GBP/USD: Pound Gains vs. Dollar Despite Dismal Forecasts Post Brexit

A cautious tone from Federal Reserve Chair Jerome Powell meant the pound US dollar exchange rate rebounded in late trading on Wednesday. The pair had traded as low as US$1.2726 earlier in the day, before dollar weakness boosted the rate to a high of $1.2847.

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 was out of favour for much of the previous session as Brexit nerves continued to weigh on sentiment. Investors digested dismal forecasts from government economists and the Bank of England surrounding Brexit. The bottom line was that any form of Brexit was going to damage the economy.

Government economists predicted that in the unlikely event of Theresa May’s Brexit deal being approved in Parliament, the UK economy would be 3.9% worse off in 15 years’ time than if it had remained within the EU.

Perhaps the most startling finding was that there was no extra value in the UK having an independent trade policy. This was one of the principal benefits of Brexit according to the Leave campaign.

Later in the afternoon, BoE governor Mark Carney painted a terrifying picture of the UK in the case of a no deal Brexit. This included the UK economy contracting by 10.5% over a five-year period. This equates to the sharpest decline since world war 2. House prices could also plummet 30%. The bleak outlook left investors little cheer and the pound plummeted.

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.

Dovish Fed Powell Pulls Dollar Lower

The dollar weakened significantly in late trade on Wednesday. A speech by Federal Reserve Chair Jerome Powell was interpreted as being dovish. Market participant expectations of rising interest rates eased after Jerome Powell said that interest rates were near neutral. This means that the Fed could slow the planned path of hiking considerably next year. As expectations of rate rises eased, so did the value of the dollar.

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 Fed will remain in focus today as the minutes will be released from the monetary policy meeting late September. The Fed raised rates at this meeting. Following Jerome Powell’s comments yesterday, investors will be looking out for other Fed official comments on the neutral rate.

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