GBP/USD: Pound Drops On Boris Johnson's No Deal Talk

The pound ended lower versus the US dollar for a fourth straight session on Tuesday. Recession fears and Brexit concerns dragged the pound to a two-year low of US$1.2440. The dollar held onto gains ahead of Fed Chair Powell’s appearance before Congress today.

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.

Things are going from bad to worse for the pound. After last week’s soft pmi readings, this week’s retail sales data from the British Retail Consortium (BRC) was no better. The BRC reported that sales dropped -1.6% year on year. This shows that whilst households are enjoying wage rises, these increases in pay are not being reflected at the tills. Given the UK economy’s reliance on the service sector, any slowdown in spending is bad news. The BRC said the outlook was “bleak” for the UK economy.

Today investors will look towards UK GDP data. Analysts are predicting the UK economy contracted by 0.1% in the second quarter. This would be the first time that the UK economy will have shrunk in 7 years and comes following a warning by Bank of England Governor Mark Carney last week. Mark Carney said the downside risk to growth had increased amid ongoing global trade tensions and the ongoing risk of a no deal Brexit.

Boris Johnson doubling down on his no deal Brexit rhetoric has done little to help the pound in early trade this morning. Boris Johnson refused to rule out suspending Parliament to push Brexit through, without a deal if necessary. This has unnerved pound trades.

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.

All Eyes on Fed Chair Jerome Powell

Dollar traders have been solely focused on Federal Reserve Chair Jerome’s semi-annual testimony before Congress later today. Investors are looking towards the Fed Chair for guidance as to where the central bank could be taking monetary policy.

Prior to last Friday’s non-farm payroll release, investors were assuming that the Fed would cut interest rates by 0.25% if not 0.5% at the July monetary policy meeting, the FOMC. Since the US jobs data showed that the US labour market was much stronger than analysts expected, investors have scaled back their bets of a rate cut in July and thereafter. Easing rate cut expectations have boosted the dollar in recent sessions.

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.

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