The pound traded in a narrow range versus the dollar in the previous week, before surging higher on Friday. The pound US dollar exchange rallied to a 7-week high of US$1.2866 on Friday, before fading slightly into the close. The pound is higher again as the new week begins.
Brexit headlines drove movement in the pound across the previous week. The pound struggled as British ministers returned to Westminster to debate the Brexit withdrawal bill for a second time. Once again MP’s have expressed opposition to the UK Prime Minister Theresa May’s Brexit deal. However, on Friday, the pound rallied strongly following reports that there was an increased likelihood of Article 50 being extended. Article 50 says that the UK will exit from the EU on 29th March 2019. An extension of Article 50 would mean that a no deal Brexit was less likely, a point that boosted 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.|
The vote in Parliament on Tuesday will be the headline event for the week. Should Parliament approve Theresa May’s deal, process will begin for the UK to exit from the European Union on 29th March. Although, there are doubts that this deadline will be met, even if the deal does get approval.
However, current MP voting intentions indicate that Theresa May’s will lose the vote by a significant margin. This will increase the level of Brexit uncertainty and chaos and could drag the pound lower. However, it could boost the pound if investors believe it means a no deal Brexit will be less likely.
A more dovish tone from the Federal Reserve across the previous week, meant the dollar was out of favour. At the start of the year Fed Chair Powell presented the market with a more cautious tone, as concerns over the outlook of the US and global economy increased. This dovish tone was evident in the minutes from the latest FOMC meeting, released last week with Fed members suggesting patience was needed regarding hiking rates this year.
As investors started questioning the probability of the Fed hiking this year, or indeed cutting instead, the value of the dollar decreased.
|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 US government shutdown continues. At 23 days it is now the longest in US history. Neither side, Trump or the Democrats are willing to conceded ground. The shutdown is keeping valuable economic data from the markets which is causing unease.
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