The pound experienced its best weekly gain versus the US dollar in almost 2 months last week. However, the 0.6% move higher in the pound US dollar exchange rate was more to do with dollar weakness than any noticeable pound strength. The pound US dollar exchange rate has started the new week on the back foot, moving lower from US$1.27.
|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.|
Despite the significantly weaker US dollar, the pound is still trading around 0.5% lower versus the dollar across December. This month has been one of the most volatile months that the pound has experienced. Investors have spent December on edge over what could happen with Brexit and with UK Prime Minister Theresa May.
Market participants are struggling to find reason to buy into the pound. Brexit is a huge factor. No-one has any idea how Brexit will plan out. Brexit uncertainties are also impacting on UK economic data. The UK could crash out of the EU without a deal or worse still for the pound, the UK could face another general election.
|How does political risk have impact on a currency?|
|Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.|
The beginning of the week will remain quiet given the UK public holiday on Tuesday. Things will start to pick up on Wednesday, with the release of UK manufacturing PMI data. British ministers are on Christmas recess until 7th January, so no major political headlines are expected.
The dollar has broadly been out of favour, albeit not as much as the pound. Firstly, investors are growing increasingly convinced that the Federal Reserve will not be able to hike interest rates as often as they initially planned amid slowing global economic concerns. Alternatively, if the Fed do go ahead and continue hiking, investors fear the central bank could damage the US economy.
|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.|
Secondly the US partial government shutdown, has still not been resolved. The shutdown is not expected to continue much into the new year. However, the political uncertainty surrounding the shutdown is keeping investors jittery.
Finally, the dollar is putting on a solid performance as the new week begins amid optimism that a trade deal could soon be agreed between the US and China. Trump said on Sunday that he had a “very long good call” with China’s President Xi Jinping. After months of trade tensions between the world’s two largest economies, the possibility of a trade agreement is starting to look up.
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.