GBP/USD: Volatility Expected From Brexit

After climbing versus a weaker dollar for much of the day, the pound suddenly fell sharply lower on Brexit woes. The pound US dollar exchange rate ended the day marginally lower versus at US$1.3267 after earlier reaching a peak of US$1.3275. This as its highest level in 10 days.

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 gained ground early on Thursday as the Bank of England (BoE) Governor Mark Carney fed investor optimism that the central bank could raise interest rates in August. Mark Carney said that the central bank continues to believe that UK economic growth picked up in the second quarter of the year after a slow first quarter. His comments come after economic data impressed this week and also pointed towards the same conclusion. Whilst Mark Carney stopped short of saying he would hike rates at the August meeting, investors are seeing it as an increasingly likely possibility. As interest rate hike hopes increased, so did 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.

The BoE inspired rally was cut short as Brexit fears returned to haunt the market. The clock is ticking until the deadline for a Brexit deal and so far, UK Prime Minister Theresa May has failed to put forward an acceptable post Brexit customs union proposal. In a meeting with German Chancellor Angela Merkel, her most recent proposal was deemed unworkable which sent the pound tumbling. A no deal Brexit is looking increasingly likely unless Theresa May and her Brexit cabinet can put a viable option together this weekend.

US non farm payroll & trade tariffs

The dollar traded broadly weaker in the previous session as investors waited for the start of the trade war. Trump said that he would put the trade levies on Chinese imports in place on Friday 6th July. China have also said that they will put counter tariffs in place the same day should the US go ahead with its threat.

Trade war concerns are likely to overshadow the non-farm payroll report, which is is usually the most watched report across the economic calendar. Analysts are expecting that the US will have had 195,000 new jobs created in June. Should the number of jobs created differ from analysts forecasts the dollar could experience volatility.

How does the non-farm payroll (NFP) affect the US dollar?
It works like this, when there is low unemployment and high job creation, the demand for workers increases. As demand for workers goes up, wages for those workers also go up. Which means the workers are now taking home more money to spend on cars, houses or in the shops. As a result, demand for goods and services also increase, pushing the prices of the good and services higher. That’s also known as inflation. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes up the currency’s worth.

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