GBP/USD: Pound Wavers vs. Dollar As Brexit Fears Dominate

The pound ended the previous week over 2% lower versus the US dollar. Sterling lost ground, with hard Brexit fears overshadowing and even a more hawkish Bank of England. The pound US dollar exchange rate dropped from US$1.4131 at the beginning of the week to a low of US$1.3765, before closing the week out slightly higher at US$1.3838 for the pound.

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.

The mood towards the pound was weak on Friday as investors reacted to disappointing economic data releases and concerns over whether the Brexit transition period will be finalized. EU Chief negotiator Michel Barnier said last week that there were still significant differences between UK and EU visions on the Brexit transition period. Furthermore, if these differences could not be resolved, the transition period was by no means guaranteed. No transition period would mean a hard Brexit, which would be the worst possible outcome for the pound.

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 sees a relatively quiet start to the week in terms of the UK economic calendar. Instead the focus of pound traders will remain on Brexit. This week UK Prime Minister Theresa May and her Brexit war cabinet are expected to unveil their vision of what relationship the UK wants with the EU after Brexit. A series of speeches are about to come as Theresa May is under increasing pressure from hardliners in the Conservative party to make a clean break with the EU. A clean beak would imply a hard Brexit, which is likely to affect the pound negatively.

Dollar higher on increased interest rate expectations

The dollar has been in favour over the past week amid a massive sell off on the US stock markets. The selloff in US stocks has come because investors believe that the US Federal Reserve will raise interest rates at a faster pace than they initially anticipated. Market participants believe that interest rate rises in the US could come faster and more aggressively which has boosted the appeal of the US dollar.

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.

The US economic calendar has a quiet start to the week, picking up on Wednesday with US inflation figures. Investors will be watching closely to see if US inflation to moving closer towards the Fed’s 2% target, which would clear the way for a March rate hike.

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