GBP/USD: Pound Vulnerable vs Dollar Ahead Of Crucial Week For UK

The pound was hard hit week by the political crisis over UK Prime Minister Theresa May’s Brexit deal last week. As a result, the pound dropped heavily versus the dollar hitting a 3-month low of US$1.2725, before edging higher towards the end of the week. The pound ended 1% lower versus the dollar and continues on shaky ground as the new week commences.

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 political outlook continues to look bleak for Theresa May as she struggles to draw support from her party for her Brexit plan. Theresa May managed to cling onto power after her Brexit Secretary Dominic Raab and 2 other ministers resigned in disagreement over her Brexit divorce deal with the EU. However, there remains a very real possibility that Theresa May could be facing a vote of no confidence at the beginning of this week as seven UK Conservative lawmakers are preparing campaigns to oust her.

Even if Theresa May does manage to hold onto power, she will still face the huge challenge of trying to get the Brexit deal pushed through Parliament. Political analysts consider this to arithmetically be an almost impossible task. With elevated Brexit and political uncertainty, the outlook for the pound is still extremely volatile. Analysts are predicting swings of over 10% in sterling between best- and worst-case scenarios.

With no economic data today, all eyes will remain on Westminster and Theresa May’s ability to hold onto power. Analysts are expecting volatility to remain high.

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.

Fed Comments Drag on Dollar

The dollar weakened towards the end of the previous week after a flurry of cautious statements from key Federal Reserve officials. Fed Chair Powell and Clarida both emphasised the headwinds that the US economy was set to face in the coming year. These included a slowdown in global growth and the fading impact of this year’s fiscal stimulus. Market participants and the Fed are not expecting these headwinds to affect the chances of a December rate hike, which has a 73% probability. However, these headwinds could impact the path of rate hikes next year. As investors reassessed rate hike expectations for 2019, the dollar slipped.

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.

US economic data is sparse this week. The most notable US data release will be Durable Goods Orders on Wednesday.

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