GBP/USD: Pound Hovers At 4 Month Low After PM Theresa May's Brexit Gamble

The pound extended its decline versus the dollar on Tuesday. Despite a brief spike higher to a peak of US$1.2812, the pound quickly dropped back to US$1.2700.

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.

Hopes of a vote in Parliament on a second referendum sent the pound soaring higher. However, gains were quickly pared, and the pound shifted back into negative territory following UK Prime Minister Theresa May’s Brexit speech. Theresa May’s desperate bid to get her Brexit deal through Parliament fell flat, pulling the pound southwards in the process.

Whilst Theresa May did offer a vote in Parliament on a second referendum, she did so on the condition that her Brexit deal was agreed on first. The was not well received by ministers. The backlash towards Theresa May started almost as soon as she finished her speech. Theresa May’s Brexit agreement looks set to fail at its fourth attempt through the House of Commons. This raises fears that a pro-Brexit candidate will replace her, which once again bring back fears of a no deal 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.

Today investors will continue to watch developments in Westminster. Investors could glance towards UK inflation data which is due to be released. Analysts are predicting that inflation ticked higher in April to 2.2%. This would be above the central bank’s 2% target.

Under normal circumstances central banks raise interest rates as a way to control inflation. Higher interest rate expectations boost a currency. The Bank of England are unlikely to change monetary policy due to Brexit uncertainties. This means that the pound’s reaction to higher inflation could be muted.

Fed Minutes In Focus

The dollar continued its ascent in the previous session, despite weaker home sales data. Investors weren’t deterred from buying into the greenback, instead looking ahead to the release of the minutes from the Federal Reserve meeting earlier this month.

Analysts are expecting the minutes to boost the dollar. In the meeting Fed Chair Jerome Powell was less cautious than investors had anticipated. He downplayed the prospects of an interest rate cut. The minutes could portray a similar message. If so the dollar could advance further.

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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