GBP/USD: Pound Dips As UK Polititcs & G20 Take Centre Stage

The dollar remained weak on Thursday as investors continued digesting the more cautious tone of the Federal Reserve. A slightly less hawkish Bank of England (BoE) and news that Boris Johnson will face Jeremy Hunt in the final stages of the Conservative leadership battle didn’t hit the pound too hard. The pound US dollar exchange rate rallied to a high of US$1.2727 before easing slightly into the close.The pound was losing ground versus the dollar on Friday.

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.

The Bank of England policy announcement was the focus for Thursday morning session for pound traders. As analysts expected, the central bank kept monetary policy unchanged. However, the central bank was more cautious over its outlook for economic growth than what analysts had forecast. The BoE revised downwards economic growth to 0% down from 0.2%. Despite the downward revision for growth and the BoE acknowledging the increasing probability of a no deal Brexit, the central bank still insisted that it would need to raise interest rates if their forecast bears out. This was more hawkish than the Federal Reserve earlier in the week.

The Conservative leadership contest was the focus yesterday evening. Favourite Boris Johnson will now go head to head versus Jeremy Hunt. Boris Johnson is a pro- Brexit supporter he won 160 votes in the final round. Jeremy Hunt was a “Remainer” three years ago he won 77 votes whilst Gove who was eliminated achieved 70 votes. The winner will be revealed in around a month.

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.

Dollar Weak Post Fed Shift

The dollar remained on the back foot on Thursday as investors continued digesting the Federal Reserve’s dovish shift. The US central bank warned that it stood ready to loosen monetary policy should it be needed, as the US economy faced increasing headwinds.

Dollar investors’ attention will now turn towards the G-20 to see whether US and China can resolve their trade row at the meeting of the 20 leaders in Osaka next week. Even so, any upside in the dollar could be limited as investors look ahead to the Fed’s July’s central bank meeting.

Why do interest rate cuts drag on 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. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available as the demand of that currency declines, dragging the value lower.

Today investors will look towards US manufacturing PMI data. In May the figure dropped sharply to 50.5. Investors will be watching to see if the sector falls into contraction, below 50. This could hit demand for the dollar further.

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