The pound plummeted 0.9% versus the dollar on Monday. Brexit fears dragged on sterling, whilst the dollar enjoyed strong demand. The pound US dollar exchange rate hit a nadir of US$1.2828 over 150 points lower than its high of US$1.3071.
|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 USDHere, £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 GBPIn 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 sell off in the pound intensified in the previous session as pound traders grew increasingly nervous over the prospect of a Brexit deal being achieved. On the one hand, EU Chief Negotiator Michel Barnier said that the Brexit Treaty text was almost ready to be presented to the British cabinet today. However, pound traders doubt whether UK Prime Minister Theresa May will be able to whip up support for the deal from her cabinet. Analysts believe that the task of pushing the deal through will be too great for the PM, as cabinet members have voiced doubts from the beginning over the deal that she is negotiating. Failure to push through the deal would make a no deal Brexit more likely as the deadline nears.
|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.
Brexit will remain in focus today. However, investors will also look towards UK jobs data today. Analysts are expecting weekly average earnings to have increased to 3% in the three months to September, up from 2.7% the previous month. Higher earnings points to increased inflationary pressure going forward. Higher inflation means an interest rate rise is more likely. Should wages increase, the pound could regain some ground.
The dollar was traded higher versus all its peers in the previous session. The dollar extended its gain for a fourth straight session versus the pound. The rally started after following the US midterm elections, when the Federal Reserve made a more hawkish statement than what the market was expecting. This has lifted hopes of more rate rises from the Fed.
|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.
With Brexit fears along with concerns over growing tensions between Italy and Brussels growing, investors looked towards the dollar for its safe haven status. Given that the dollar is the global reserve currency, when geopolitical concerns increase investors tend to look towards the dollar.
Today there is no high impacting US economic data. Investors will be looking towards US inflation data on Wednesday.
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