GBP/USD: Will Trade Talk Developments Pull The Dollar Lower vs. Pound?

Growing doubts over the Federal Reserve’s ability to hike interest rates next year and the growing possibility of a no-deal Brexit, saw the pound US dollar exchange rate rally on Monday. The pound jumped 0.3% versus the dollar to a weekly high of $1.2790. The pair is moving lower in early trade on Tuesday

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.

Labour, the opposition party, are to support an amendment in the finance bill which is expected to make a no-deal Brexit increasingly unlikely. Whilst many ministers are against UK Prime Minister Theresa May’s Brexit deal, very few are in favour of a no-deal Brexit. Political analysts are expecting to see several tactics over the coming days to prevent a no-deal Brexit, even in the case that Theresa May’s Brexit deal is voted down on 15th January.

Leading economists and business leaders have often voiced their concerns over the damage that a no-deal Brexit would have on the UK economy. Any signs that the chances of a no-deal Brexit are fading, 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.

Today, the UK economic calendar is light. The nationwide house price index could attract some attention as investors assess the mood of the consumer. However, Brexit headlines are more likely to continue driving the price of the pound.

Dollar Drops Further On Dovish Powell & Weak Data

The dollar extended losses from Friday following Federal Reserve Powell’s more cautious tone. As the Fed confirms that its policy outlook is flexible, investors are increasingly certain that the central bank will not manage the 2 or 3 rate hikes planned or this year. Instead investors are increasingly believing that the Fed will cut interest rates this year, rather than hike, as US economic growth and global growth are forecast to slow.

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 latest US data, the US service sector PMI, supported the idea that the US economy was slowing. Activity in the service sector fell to 57.6 in December, down from 60.7 in November. This is the slowest level of growth in the sector for 5 months, fuelling concerns that momentum is declining in the economy, dragging the dollar lower.

US — China trade talks will enter the second day today and comments from each side have been encouraging. With very little in the way of US data being released owing to the US government shutdown, investors will watch the trade talk’s developments closely. Good progress in the talks could see investors sell out of the dollar, no longer demanding its safe haven attributes.

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