GBP/USD: Pound Traders Look Ahead To First Conservative Leader Vote

Brexit nerves sent the pound plummeting against the US dollar on Wednesday, even as market expectations of an interest rate cut by the Federal Reserve increased. The pound US dollar exchange rate dropped to a low of US$1.2682.

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.

Brexit was under the spotlight in the previous session. Firstly, the polls favourite, pro-Brexit and ex-foreign minister, Boris Johnson launched his Tory leadership bid. Boris Johnson’s policy of Brexit with or without a deal had unnerved pound traders leading up to today. However, in his speech Boris Johnson actually warned against a no deal Brexit. He was much less enthusiastic about a no deal Brexit than he had been previously and also spoke of support for the UK financial services. Pound traders breathed a sigh of relief and the pound moved cautiously higher in early trade.

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.

Strength in the pound was short lived in the previous session. The pound dropped sharply lower as the government defeated a move by Labour leader Jeremy Corbyn to attempt to block a no deal Brexit. The vote of 309 versus 298 leaves the door open for a pro- Brexiteer Tory leader to take control, a boost for Boris Johnson.

The returning threat of a no deal Brexit sent the pound tumbling. Economists have frequently stated the negative effect that a no deal Brexit will have on the economy.

Today there is no high impacting UK economic data. Investors will focus on developments at Westminster. The first ballot takes place for the Conservative leadership challenge. Any candidate failing to secure 17 votes is eliminated.

Dollar Drops On Interest Rate Cut Expectations

The dollar was broadly out of favour following another round of weak data, prompting investors to speculate on the Federal Reserve cutting interest rates sooner rather than later. US consumer inflation increased just 1.8% year on year in May. This was below the 1.9% that analysts had forecast and was down from April’s 2%. Core inflation also unexpectedly fell to 2%.

The weak data comes following a surprisingly soft jobs report on Friday. Weaker job creation, lower than expected wage rises combined with low headline inflation could prompt the Fed to lower interest rates as soon as July.

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.

Initial jobless claims could catch the attention of traders today. Any further trade headlines could also impact the dollar as investors start to turn their attention towards the G20 meeting later this month. President Jinping Xi has not confirmed whether he will meet with President Trump to discuss trade.

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