The pound finished lower versus the dollar on Friday. The pound US dollar exchange rate dropped to a low of US$1.3147 after having reached a peak over 100 points higher earlier in the session. The pound just managed to cling on to a weekly gain versus the broadly weaker dollar. However, sterling is looking decidedly softer versus the buck as trading kicks off again for the new week.
|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 started the previous week off on the right foot. Sterling gained versus the weaker dollar on Brexit optimism until Friday. A lack of any solid Brexit developments weighed on sentiment and sent the pound 0.6% lower.
This week Brexit will remain the key driving force for the pound. Speculation had been mounting that the terms of a Brexit deal could be agreed on as soon as Monday ahead of the EU leaders’ summit on Wednesday. However, a dramatic twist over the weekend means a no deal Brexit is looking increasingly more likely.
UK Prime Minister Theresa May warned the EU that a draft treaty to take Britain out of the EU was a “non-starter” and risked tearing her government apart. This means that Brexit talks are almost at a standoff on Sunday evening, with no further talks scheduled before the leader’s summit. There is a real danger of talks completely breaking down, leaving the UK heading towards and economically damaging disorderly, no deal Brexit.
|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 dollar was under pressure for most of the previous week despite market participants believing that the Federal Reserve could rise interest rates at a faster pace. Recent US data economy has showed the economy to be firing ahead. A central bank would normally look to raise interest rates under such circumstances to prevent the economy from overheating.
|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.|
Inflation figures that were weaker than analysts’ expectations, lowered the dollar again on Thursday. However, the greenback rebounded on Friday as investor’s confidence in the US economy improved once again.
This week the Fed’s future intentions will remain in the spotlight as investors look towards the release of the minutes from the FOMC meeting. These could provide further clues as to what the Fed’s future rate path looks like. Prior to that, US retail sales will be released today, which could provide some volatility.
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