The pound’s reaction to the second meaningful vote in Parliament on Tuesday was muted. The post vote move paled in comparison to the volatility that the pound had experienced across the session prior to the vote. The pound US dollar exchange rate closed Tuesday down 0.6% at $1.3065. The pair was trading 0.1% higher in early trade on Wednesday.
|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.
Theresa May’s Brexit vote was defeated in Parliament for a second time on Tuesday. The PM lost the vote by an ample 149 majority. Although this was an improvement on her previous historic loss of 230 votes.
Earlier in the day the UK’s top lawyer had said that the new concessions from Brussels were not legally binding. As a result, the House of Commons made it clear, for a second time, that they do not support the PM’s current Brexit deal.
Today Parliament will have a free vote on leaving the EU with no deal. Political analysts are confident that Parliament will vote against a no deal Brexit. This is offering some support to the value of the pound.
On Thursday we enter extension territory. The House of Commons will vote on whether to extend Article 50. This would open the door to further negotiations or even a second referendum. Both of these options could be supportive of the pound as they imply a softer Brexit.
|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 was broadly out of favour on Tuesday, albeit strong than the pound. Dollar weakness stemmed from soft inflation data. The Consumer Price Index showed inflation ticked lower to 1.5% in February, down from 1.6% in January. Core inflation, which discounts more volatile items such as food and fuel also ticked lower to 2.1%.
Falling inflation, in addition to slowing growth supports the Federal Reserve’s patent approach to tightening monetary policy. The Fed has pressed the pause button on hiking interest rates and whilst growth and inflation figures tick lower, they are unlikely to start raising rates again. The pushing back of rate hike expectations sent the dollar lower.
|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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