GBP/USD: Dollar Weakens vs. Pound On Expectations Of A Hike From Feds

The pound closed the previous session higher versus the dollar for the third straight day on Tuesday. After hitting a high of US$1.2706, the pair faded into the close, to end the session at US$1.2654. The pound is trading higher versus the dollar in early trade on Wednesday as investors look towards the Federal Reserve monetary policy announcement.

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 moved higher versus the dollar in the previous session despite the government ramping up no deal Brexit planning. There is still a great deal of uncertainty over whether UK Prime Minister Theresa May will be able to push her deal through Parliament or not. The alternative being a hard, no deal Brexit. Usually any signs of a no deal Brexit sends the pound tumbling lower. Economists have frequently discussed the damaging effect that Brexit and more specifically a no deal Brexit would have on the UK economy.

However, rumours about a second referendum are refusing to die down. These rumours are offering support to the pound. Any hope that the UK could have a softer Brexit, or avoid Brexit altogether lifts the pound.

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.

In-between Brexit headlines investors will turn their attention towards UK inflation data. Analysts are expecting inflation in the UK to have ticked lower in November to 2.3%, down from 2.4%. Analysts also expect core inflation, which excludes more volatile items such as food and fuel to tick lower to 1.8% down from 1.9%. The Bank of England are unlikely to hike rates when Inflation is falling, therefore a softer inflation reading could pull the pound lower.

A Final Hike in 2018 From The Fed?

The dollar has been falling across the week as investors eye the Federal Reserve policy announcement at 2pm E.T today. Investors are placing a 72% probability on the Federal Reserve hiking for a fourth time this year. However, most attention will be placed on what the Fed plan to do next year.

With concerns growing that the global economy is heading towards a slowdown, investors do not believe that the US economy can handle higher borrowing costs and they will be looking for agreement from the Fed on this. The Fed are currently planning 3 hikes next year. Investors will want to see this reduced to two. Should the Fed reduce the outlook, the dollar could fall further.

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.

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