GBP/USD: Pound Closes Higher As Brexit Extended Until October

The pound pushed higher versus the US dollar on Wednesday. A medium length extension to Brexit, stronger than forecast UK GDP data and a Federal Reserve in no rush to raise interest rates pushed the pound US dollar exchange rate to a high of US$1.3120. The rate eased towards the close, finishing the session 0.2% higher at US$1.3090

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.

The pound moved higher across the session on Wednesday, as investors remained fixed firmly on Brexit. Theresa May formally requested a short Brexit extension to 30th June. However, the EU agreed to an extension until 31st October, with a break clause at the end of June to please French President Macron. The good news for the pound is that the UK won’t be crashing out of the EU without a deal on Friday.

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.

A six-month extension is just about enough time to oust Theresa May and replace the Prime Minister. The UK taking part in European Elections in May, some three years after Britain voted to leave the EU, will be unacceptable to many Brexiteers.

With so much attention on Brexit, investors paid little attention to UK GDP data. The UK economy grew by more than expected in the three months to February. The GDP printed at 0.3%, above the 0.2% that analysts had predicted. On a monthly basis the UK economy grew 0.2%, better than the 0% that analysts forecast.

Delving deeper into the figures, it became apparent that the UK economy received an unexpected boost from Brexit fuelled stockpiling. This is not sustainable meaning that weakness could come further down the line to compensate.

Dovish Fed Hits Dollar

US Federal Reserve minutes showing that the central bank was in no rush to raise interest rates hit demand for the dollar in the previous session. The Fed doubled down on dovish rhetoric in the March meeting. Minutes from the meeting showed that policy makers were keeping their options open for the next move in rates, which could move in either direction. The use of the phrase either direction is an indication that monetary policy could be eased or tightened. This is a big change from the three-interest rate rises originally planned for this year. The increased doubt over any interest rate weighed on the mood for the dollar.

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.

Today investors will be watching US wholesale inflation figures closely after core consumer inflation dropped lower and missed analysts’ forecasts. Weakness in inflation at wholesale level could pull the dollar lower.

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