The pound surged 2.5% higher versus the US dollar in the previous week. Its sixth straight week of gains versus the dollar. Brexit optimism saw the pound US dollar exchange rate jump to a high of US$1.3218 on Friday. This is a level that hasn’t been seen since mid-October last year.
|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 = 1.13990 EUR
Here, £1 is equivalent to approximately €1.14. This specifically measures the pound’s worth against the euro. If the euro amount increases in this pairing, it’s positive for the pound.
Or, if you were looking at it the other way around: 1 EUR = 0.87271 GBP
In this example, €1 is equivalent to approximately £0.87. This measures the euro’s worth versus the British pound. If the sterling number gets larger, it’s good news for the euro.
The pound has continued to charge higher as investors become increasing certain that the UK will not crash out of the EU without a deal. Whilst ministers voted overwhelmingly against UK Prime Minister Theresa May’s Brexit deal, in early January, very few are actually in favour of a no deal scenario. This is because of the economic damage that a no deal Brexit would have on the UK.
Theresa May’s pan B, proved to be almost identical to her Plan A. However, the DUP have pledged their support towards Theresa May’s deal should she manage to agree a clear time limit to the Irish backstop arrangement. However, in a blow to Theresa May unblocking the current political impasse, the Irish Prime Minister has once again said that he is strictly opposed to a time limit being imposed.
Brexit developments will continue to drive movement in the pound this week as a key vote in Parliament on Tuesday could see Theresa May lose control of Brexit. Parliament could look to extend Article 50, pushing Brexit back. Alternatively, it could send Theresa May back to Brussels for further negotiation. Any step away from a hard no deal Brexit will support 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 dollar traded broadly lower across the previous week as concerns over the impact of the extended shutdown of the US government hit demand for the greenback. US government workers were not paid across a one-month period, whilst the shutdown was in place. Dollar traders were nervous that this will impact on the economy, providing another reason for the Federal Reserve not to raise interest rates.
|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.|
Over the weekend, President Trump caved in to Democrat forces and ended the longest shutdown in history. However, he has said he is in favour of a second shutdown. For now investors will shift their focus to US — Sino trade talks, the Fed and US Jobs report in a very busy week ahead for the dollar.
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