The pound fell for its fourth consecutive week versus the dollar in the previous week. The pound US dollar exchange rate hit a 17-month low of US$1.2659 as investors looked nervously ahead to this week’s Brexit vote.
|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.|
Last week there were some significant Brexit developments. The European Court of Justice suggested that the UK could unilaterally opt to end Brexit, this will be confirmed in a ruling by the ECJ today. UK Parliament also voted to give itself the power to take control of the next steps in Brexit should Theresa May lose the vote in Parliament. These were both positive developments for the pound. This is because they increase the chances of Brexit not happening or of a softer version of 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.|
However, these positive pound developments were quickly overshadowed by Bank of England Governor Mark Carney’s comments over the forecasted negative impact of Brexit on the economy. Mark Carney has previously claimed that a worst-case scenario could see the UK economy contract by over 8% next year.
This week the pound is facing one of its most important weeks since the Brexit referendum in June 2016. After two years of negotiating Parliament are expected to vote on the Brexit deal on Tuesday 11th December at around 22:30 (GMT). Political commentators and analysts are widely expecting Theresa May’s deal to be voted down by a large majority. This will open the door to significant uncertainty for the UK economy and therefore the pound. Reports are still circulating that Theresa May could postpone the vote to see if she can squeeze more from Brussels.
The dollar was broadly lower during the day on Friday, albeit stronger than the very weak pound. US jobs data was much lower than analysts had been expecting. Only 155,000 jobs were created in the US in November. This is significantly lower than the 198,000 that economists had penciled in. Average earnings were also weaker than analysts had forecast. The softer data has fuelled concerns that the US economy is starting to slow and that the Federal Reserve will stop hiking interest rates after an increase in December.
|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 little in the way of high impacting US economic data, investors will switch their attention back to the US-China trade war. Whilst tensions had eased following the G20, the arrest of the CFO of one of China’s largest technology firms – Huawei – in Canada for extradition to the US has hit sentiment. Relations between the two powers have soured rapidly.
This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from TransferWise Inc., Currency Live or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date. Consult our risk warning page for more details.
This article was initially published on TransferWise.com from the same author. The content at Currency Live is the sole opinion of the authors and in no way reflects the views of TransferWise Inc.