GBP/EUR: Brexit Dominates Undermining The Pound

Brexit optimism and dire US data sent the pound US dollar exchange rate to a 5-month high on Wednesday. The pair rallied to a high of US$1.2837 before easing slightly into the close. The pair is edging lower in early trade on Thursday.

Pound investors jumped from Brexit headline to headline in the previous session in an attempt to gauge the likelihood of a Brexit deal going through. Comments from German Chancellor Angela Merkel and French President Macron that the Brexit deal was being finalised helped boost optimism that a deal would be completed in the coming days.

Today, however, the Northern Irish DUP party, whose vote is critical to push the Brexit deal through Parliament have rejected Boris Johnson’s new Brexit deal “as it stands”. Without the DUP’s backing Johnson cannot be sure of a majority in the House of Commons. This will have repercussions in Brussels where leaders are attempting to hammer out a deal before the end of the day. Investors will continue watching Brexit developments closely as the EU Summit begins.


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 Drops On Dismal Data, More To Come?

The dollar trended lower versus all major currencies on Wednesday following dismal US retail sales figures. US retail sales declined -0.3% month on month in September, well below August’s 0.6% increase. Analysts had been expecting a 0.3% increase in September. The hugely disappointing figures sparked concerns over the health of the US economy. Up until now the US economy had remained resilient, despite the slowdown in manufacturing, owing to strong consumer spending.

The US consumer is a central pillar in the service dominated economy; signs that the consumer is starting to crack could mean that the US economy is heading for a sharp slowdown. In this scenario the Federal Reserve would be forced to cut interest rates for a third time this year. The prospect of a slowing economy and more rate cuts sent the dollar lower.


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 there are several pieces of mid -tier data due to be released. The most closely watched will be US manufacturing and industrial production. Analysts are expecting -0.2% and -0.3% declines respectively. Weak figures could further fan fears of the state of the US economy and more particularly the US manufacturing sector. As a result, the dollar could move lower.

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.


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