The pound US dollar exchange rate experienced heavy volatility on Wednesday. The pound US dollar rallied from a low of US$1.3138 to a high almost 100 points higher, before falling back to US$1.3165 towards the close.
The pound received a boost in early trading from increased Brexit optimism. The leader of the opposition party, Jeremy Corbyn boosted hopes of a softer Brexit deal in his speech at the UK Labour party’s annual conference on Wednesday. Corbyn had previously said that he and his party to not vote in favour of any Brexit deal that UK PM tries to push through Parliament. In his speech at the conference he softened his stance, saying that he and Labour would vote through a Brexit deal that keeps the UK in the single market and customs union. His comments boosted hopes of a softer Brexit which lifted the pound.
Leading economists and business leaders have frequently said that a softer version of Brexit would be the least damaging option to the UK’s economy.
| Why is a “soft” Brexit better for sterling than a “hard” Brexit? |
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| 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 there is no high impacting data for investors to focus on. Instead Bank of England Governor Mark Carney will be speaking in Frankfurt. If Mark Carney should touch on tighter monetary policy, like his colleague did earlier on the week, the pound could rise higher.
| Why do raised interest rates boost a currency’s value? |
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| 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. |
Fed Hikes Rates
The dollar was under the spotlight in the previous session as the Federal Reserve voted to raise interest rates. As analysts had predicted the Fed hiked by 0.25% to 2.25%, in its third rate rise of the year. The central bank said that it intends to continue with its current path of hiking, with analysts expecting the next hike in December. There were no surprises from the Fed, which struck an upbeat tone regarding the health of the US economy.
Whilst Fed Chair Jerome Powell brought up the US -Sino trade spat, he also mentioned that there is no evidence of the tariffs lifting US consumer prices. For this reason, the Fed has said that it will continue on its current path until there is evidence to prove that a different course of action should be taken.
Today is another big day for the dollar with a slew of US data due to be released, including US GDP. Signs that the US economy continues to power forwards could boost the dollar.
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