The US dollar traded lower versus the pound on Friday, boosting the pound US dollar exchange rate to a day’s high of $1.4172. The rate then eased back slightly into the close. The pound US dollar rate increased an impressive 1.3% across the previous week, its third straight week of gains.
|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 outlook for the pound improved, after the EU leaders at the EU Summit, on Friday, agreed the terms to the transition deal. The agreement of this deal has laid the foundations to a smoother Brexit deal and is the groundwork for the next phase of the Brexit talks. The deal should give increased clarity to businesses and has given investors increased optimism that the UK could avoid a hard Brexit, which would be most damaging to UK business 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.
The other factor boosting the outlook of the pound is growing optimism that the Bank of England (BoE) will look to raise interest rates in May. The BoE meeting last week ended with a surprise vote split, which showed that two policy makers voted to hike rates immediately. With wages increasing and the economy stabilising, investors consider that the central bank will have more flexibility and a more stable economy on which they could raise interest rates.
|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 such a pivotal week last week, this holiday shortened week is set to be much quieter. The UK economic calendar is shot on high impacting data.
The dollar was under pressure for much of the previous week as investors fear a full-on trade war. President Trump announced new trade tariffs to be placed on $50 billion worth of Chinese imports. The Chinese then responded by drawing up a list of 128 US products which will be target should no agreement be reached.
A trade war between the two largest economies in the world could do a significant amount of damage to both economies and is weighing on sentiment for the US dollar. Whilst US economic data was strong at the end of last week, investors remain more concerned over whether these tit for tat responses will end in a large scale trade war.
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.