Brexit optimism and the dollar rally losing steam saw the pound US dollar exchange rate advance on Tuesday. The pair rallied to a high of US$1.2182. The pound US dollar rate is falling in early trade on Wednesday amid growing Brexit nerves and ahead of the release of US Federal Reserve minutes.
|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 the central driving force for the pound on Tuesday and will be again today. Prime Minister Boris Johnson will visit Germany’s Angela Merkel and France’s President Macron to request that the EU drops the Irish backstop. Comments by Angela Merkel raised hopes that the EU will soften its tone on Brexit, as a result the pound moved higher. However, the European Council President Donald Tusk also firmly rejected Boris Johnson’s demand to scarp the backstop, saying that the UK lacks realistic alternatives to prevent a hard border after Brexit.
As no deal Brexit preparations move up a gear, pound traders are becoming increasingly nervous. Prime Minister Boris Johnson has said that the UK will drastically reduce its contact with the EU in 10 days to concentrate on no deal Brexit planning. This could weigh on demand for the pound as disorderly Brexit fears escalate.
|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.|
US Federal Reserve Minutes Up Next
The US dollar edged lower in the previous session, in a quiet session amid a lack of macro-economic data and no major developments regarding the US — Sino trade dispute.
Today dollar investors will be looking ahead to the release of the minutes from the Federal Reserve Monetary policy meeting, the FOMC, from July. This will allow investors to scrutinise deliberations by policy makers as the central bank moved towards its first interest rate cut in a decade. However, as the FOMC was prior to the recent escalation in US — Sino trade tensions, they might appear more hawkish relative to the current dollar pricing.
Market concerns over the health of the US economy have risen recently as rising US — Sino tensions and a deteriorating global environment are fuelling concerns of a recession. These fears won’t be in the Fed minutes. However, these concerns will almost certainly be addressed by Jerome Powell when he speaks on Friday at the annual central bankers gathering in Jackson Hole, Wyoming.
|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.|