GBP/USD: UK Political Plays To Drive The Pound

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The pound finished the previous week over 1% higher versus the dollar. The pair closed the week at US$1.2742 and is seen moving higher in early trade on Monday. This is more of a dollar weakness story than owing to any notable strength in the pound.

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 pound was broadly weaker in the previous week versus its peers, except for the dollar. The Conservative leadership battle grabbed most attention. Favourite and pro-Brexit Boris Johnson made it through to the final round of voting with 160 votes. Jeremy Hunt came second with 77 votes. The two will now face each other in a final postal vote with results due in a month’s time.

Given Boris Johnson’s pledge to remove the UK from the EU with or without a deal, pound traders are nervous. Business leaders and economists have frequently warned over that damage a no deal Brexit could cause the UK economy. Whilst the increased possibility of a no deal Brexit lingers, the pound could struggle to move higher versus its peers.

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.

The Bank of England Governor Mark Carney also hit demand for the pound in the previous week. A downward revision of UK economic growth for the second quarter unnerved pound investors. The BoE now forecast 0% growth in the second quarter, down from 0.2%. The central bank cited Brexit and a global economic slowdown as the main headwinds facing the UK.

This week the UK economic calendar is light. Today investors will be watching for any clarification from Boris Johnson over the home argument to which the police were called over the weekend.

Dollar Investors Look To G20 Later In The Week

The dollar dropped sharply across the board in the previous week after a dovish message from the Federal Reserve. At the latest FOMC meeting, Fed chair Jerome Powell signalled that the Fed was prepared to loosen monetary policy to support the economy should it be required. Dollar investors are assuming that the Fed will cut interest rates potentially as soon as next month. The prospect of lower interest rates pulled 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.

There is little in the way of high impacting US data today. There are some data points across the week that could attract dollar investors attention. Investors will be focusing on the G20 starting 28th June, where President Trump is due to speak with China’s President Jinping Xi.


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