The pound tumbled lower versus the US dollar in the previous session. US government news boosted the dollar, whilst pound traders looked nervously ahead to the Bank of England interest rate announcement today. The pound dropped to a low of $1.3849, before climbing slightly higher towards the end of the session.
|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.
With little in the way of high impacting economic data to drive direction in the pound in the previous session, investors focused on Brexit developments. UK Prime Minister Theresa May met with her Brexit cabinet, a group of senior ministers, to decide on the end state for the UK after Brexit. The group includes ministers from both sides of the Brexit fence. A final decision is unlikely until next week. However, investors will be watching any headlines in the meantime, looking for signs of that Britain will be closely aligning itself with the EU to prevent a hard Brexit.
|Why is a “soft” Brexit better for sterling than a “hard” Brexit?|
|A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.|
Today at 12:00 GMT, the BoE will release its interest rate decision, followed by minutes from the monetary policy and the quarterly inflation report. Analysts are expecting the central bank to keep rates on hold. Therefore, the central focus will be on the inflation report and economic forecasts. These will be the first updates since the BoE raised rates in November. Some market participants had believed that the central bank would be slightly more hawkish, given improved sentiment and strong economic growth in the fourth quarter. However, given looming Brexit uncertainties the central bank is more likely to remain in a wait and see mood
|Why do raised interest rates boost a currency’s value?|
|Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.|
News that US Senate leaders have managed to agree a 2-year budget deal pleased the markets. This means that the US government will remain funded for 2 years, lifting caps on military and domestic spending and putting an end to shutdown threats which have plagued congress. Whilst there are many positives to this, the most obvious downside is that this will add to the deficit, which is already ballooning after the Republican tax cut. However, dollar traders have been able to focus on the benefits of no more uncertainty from government shutdowns for 2 years, boosting the dollar.
This article was initially published on TransferWise.com from the same author. The content at Currency Live is the sole opinion of the authors and in no way reflects the views of TransferWise Inc.