The pound managed to claw back some lost ground versus the dollar on Friday. However, it was a case of too little too late. The week the pound devalued over 1.8% against the US dollar across the week. As trading begins on Monday, the pound was holding its ground.
|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 = 1.13990 EUR
Here, £1 is equivalent to approximately €1.14. This specifically measures the pound’s worth against the euro. If the euro amount increases in this pairing, it’s positive for the pound.
Or, if you were looking at it the other way around: 1 EUR = 0.87271 GBP
In this example, €1 is equivalent to approximately £0.87. This measures the euro’s worth versus the British pound. If the sterling number gets larger, it’s good news for the euro.
Domestic political woes and Brexit uncertainty sent the pound tumbling across the previous week. There is a sharp divide within UK Prime Minister Theresa May’s government over the direction of Brexit. Last week, fears were growing that Theresa May was losing control of her cabinet because of the divide. The ramping up of no- Brexit plans also unnerved investors.
|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.
This week will be a busy week for pound traders with the UK budget today and the Bank of England (BoE) rate announcement on Thursday.
The UK Chancellor of the Exchequer, Philip Hammond, will present his Autumn Budget today around 14:30 local time. He will announce the beginning of the end of austerity, with an increase in spending on roads, broadband and defence. This could help boost the pound, This is because increased spending increases inflationary pressures, increasing the likelihood of an interest rate rise.
|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.
However, the increase in spending will come with a stark warning. If no Brexit deal is agreed within the coming weeks, then the Chancellor will have to present an emergency budget. Many economists have said that a no deal Brexit will damage the UK economy. A no deal Brexit will require a rewriting of the government’s economic strategy and spending plans.
Demand for the dollar was strong across the board in the previous week. As the list of geopolitical concerns keeps growing and as the US stock markets plummeted, investors looked towards the US dollar for its safe haven properties. As the world’s global reserve currency, when geopolitical tensions rise, investors opt for safety. Current tensions include concerns of the potential clash between Brussels and Rome over Italy’s spending, Brexit, the growing isolation of Saudi Arabia following the death of Jamal Khashoggi and fears over the US exiting a nuclear deal with Russia.
US GDP data beat analysts’ expectations, growing at 3.5% in the third quarter. Investors will turn their attention to the economic calendar this week for further signs of strength in the US economy with US jobs data on Friday being the highlight for the week.
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