GBP/USD: Weak US & UK Service Sectors Disappoint Investors

The pound US dollar exchange rate had a volatile session on Tuesday. Brexit pain and optimism, in conjunction with US tax euphoria and weak economic data saw the rate fall sharply lower, before steadily regaining ground, then falling again. The pound US dollar exchange rate hit a session low of US$1.3373 for the pound, before pushing higher and then falling later as the session closed.

What do these figures mean?

When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written: 1 GBP = 1.28934 USD

Here, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the US dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 USD = 0.77786 GBP

In this example, $1 is equivalent to approximately £0.78. This measures the US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

Reports of a Brexit deal breakthrough at the beginning of the week have proved to be premature. When investors realised this, the pound quickly sunk lower, while poor UK service sector data exasperated the decline.

The UK service sector, in November, slowed significantly compared to October and also fell short of analysts’ expectations. One of the most troublesome areas of the report was the noticeable slowdown in hiring in the service sector. Firms didn’t make new hires due to economic and political uncertainty, in addition to increasing costs. Given that the service sector accounts for over 80% of economic activity in the UK, a slowdown in hiring could have a serious impact on the economy.

Why does poor economic data drag on a country’s currency?
Slowing economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.

As investor attention switched back to Brexit, the pound was able to pull itself off the session low and grind higher, before falling again. This reflects the wildly changing expectations that traders have of the UK and the EU reaching a Brexit divorce deal. Today UK Prime Minister, Theresa May, was expected to return to Brussels. However reports are surfacing that the trip has been cancelled, due to a lack of progress over the Irish border problem. Mat desperately needs to find a solution that the DUP (the northern Irish party propping up the UK government) are willing to back.

US tax reform progression and jobs in focus

After the US Senate approved Trump’s US tax reform bill last week, Republicans are now combining it with the House versions, to arrive at the final bill. There are several important differences between the two bills, such as the number of tax brackets, healthcare, inheritance tax to name a few. This will not be an easy job. However, US President Trump is keen to score his first legislative victory, so there will be a lot of pressure for the task to be completed quickly. Dollar traders continued to cheer the progress.

How would Trump’s policies boost the US dollar?
A sizeable corporation tax cut would see a flood of money repatriated to the USA which would then create a high demand for the currency. In turn, this would increase its value versus other currencies. Infrastructure spending in a country already close to full employment would also push wages higher, leading to more spending and thus boosting inflation. Higher inflation leads to higher interest rates and a higher demand for the currency.

Keeping a cap on dollar strength was news that US service sector growth cooled in November. It fell from 60.1 last month to just 57, this month. However, as it remains firmly over 50, the line which separates expansion from contraction, concerns should be short lived.

Today the focus will start shifting towards the US jobs report at the end of the week. Investors will look towards today’s private payroll report to begin assessing health of the US labour market.

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