GBP/USD: Pound Lifted vs. Dollar on Potential Soft Brexit Backstop

The pound is finally made some headway against the dollar, trading higher for the first session in 3. Despite weak UK data and a cautious Bank of England (BoE), the pound moved 0.2% higher versus the buck, hitting a high of US$1.3566 before selling into the close.

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.

A UK newspaper reported earlier in the week that he UK Government was to tell Brussels that they will stay in the customs union after Brexit in 2021. This report was not entirely correct. The government announced that the UK will ask the UK to remain in the customs union should they not be able to find a satisfactory solution to the Irish border issue. In other words, if there is no other solution to prevent a hard board in Ireland, the UK will remain part of the EU. This has been agreed by all of the Brexit cabinet and now awaits agreement from Brussels. This means that there is a higher probability of a soft Brexit, which is less disruptive for UK businesses and therefore more beneficial for 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.

There is no high impact UK data due for release today. Investors will look ahead to inflation figures which are due for release next Wednesday. Some analysts are predicting that inflation will have moved higher in April. Should this be the case, the pound lift higher as higher inflation boosts the chances of the central bank hiking 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.

China Trade Talks in Focus

Data this week has generally been supportive of the US dollar. Industrial production came in higher than what analysts had been anticipating and US retail sales prior to that were also stronger than forecasts. As a result, general optimism towards the US economy has been strong, which has helped keep the dollar up at 5-month highs.

The US economic calendar is quiet today and remains quiet until the middle of next week. In the meantime, investors will be keep an eye out for any news on the US China trade talks which are underway at the moment.

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