The pound drifted lower versus the US dollar in the previous session before rebounding sharply. With no new data or headlines to direct either the pound or the US dollar, momentum from Friday’s session kept the pound out of favour, before reversing later in the session. Sterling dropped to a low of US$1.3796 before climbing back to US$1.3850.
|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 pound traded lower at the beginning of the new week as Brexit concerns remained on investors minds. At the end of last week Chief EU negotiator Michel Barnier unnerved pound traders by saying that given the vast differences between the UK and the EU, the post Brexit transition period may not happen. Without a transition period, UK businesses and the UK economy could suffer a cliff edge change, which would be the worst scenario for both the UK economy and 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 investor attention will switch back towards UK economic data, with the release of the Consumer Price Index (CPI). The CPI measures inflation in the UK economy. Analysts are expecting headline inflation to have dropped from 3% in December, to 2.9% in January. Meanwhile, core inflation, which strips out more volatile items such as food and fuel is actually set to increase from 2.5% to 2.6%. Both figures are still significantly above the Bank of England’s 2% target rate for inflation. The Bank of England made some hawkish comments last week, saying that interest rate rises could come sooner and be greater than the bank had initially anticipated. With this in mind, a higher inflation reading than analyst forecast could help cement the odds of a rate rise in May, which woulld boost the pound.
|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.
After the dollar strengthened last week, the mood towards the greenback eased at the start of this week. A big announcement from US President Donald Trump, with the unveiling of a massive infrastructure project, which will entail spending in the region of $1 – $1.5 trillion dollars in total, failed to boost the dollar. Usually this type of project would boost the economy, pushing the dollar higher. However, a lack of details means that the markets are not yet convinced over the project.
Today looks set to be relatively quiet for the dollar, with investors focusing on US inflation data on Wednesday, which will take centre stage.
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.