The pound declined to fresh 2018 lows on Monday after two weeks of holding relatively steady around US$1.3500. The pound US dollar exchange rate hit a low of US$1.3391 below lifting back above US$1.34 towards 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.
The pound dropped strongly in early trade on Monday as politics dominated traders’ attention. Firstly, investors responded to news that Scottish Prime Minister Nicola Sturgeon will revisit the idea of Scottish Independence once there is more clarity on Brexit. There was a Scottish Independence referendum before Brexit, however Sturgeon is keen for the Scots to vote again once they have a better idea of what post Brexit UK will look like. This is a big political risk for Britain.
|How does political risk have impact on a currency?|
|Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.|
Adding to the pound’s woes, UK Foreign Secretary and hard line Remainer Boris Johnson aimed a thinly veiled warning to UK Prime Minister Theresa May, advising her to stick to her promise of leaving the EU customs union. His warning comes after an announcement last week that that the UK government had agreed to remain in the EU customs union, as a back stop, post 2021 to prevent a hard border in Ireland. Johnson warned Theresa May against using the backstop instead of sticking to her promise to leave. Disagreement over Brexit is still rife in the UK governing Conservative party, with some analysts suggesting that there might be an election as soon as this Autumn if the party can’t resolve its problems.
The dollar was in demand once again at the start of the week. News that US and China had made progress in trade talks and had stepped back from the brink of a trade war, boosted investor interest in the dollar. The US had agreed to put on hold trade tariffs, whilst in exchange China agreed to increase US exports, particularly farming products and energy. Increased trade and less restrictive trade policies is good news for the dollar, which helped send it higher.
However, interest in the dollar dramatically reversed following comments from Federal Reserve official Harker. Mr Harker was unexpectedly rather cautious on the outlook for inflation, suggesting that there weren’t even early signs of a rapid pick up in inflation. A more cautious sounding Fed means that interest rates are less likely to be hiked more quickly that the current implied path. As a result, the dollar weakened.
|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.|
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.