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GBP/USD: Will UK Inflation Calm Brexit Concerns Among Investors?
Brexit chaos in the UK Conservatives plus an upbeat testimony from the Federal Reserve Chair made for a volatile session for the pound US dollar exchange rate on Tuesday. The pair fell 1.5% at its worst, hitting a low of US$1.3070 before rebounding close at US$1.3110.
| 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. |
Whilst analysts believed the UK jobs report might have distracted pound traders from Brexit uncertainties on Tuesday, it failed to do so. The pound was on the decline even before the disappointing wage data, after Bank of England Governor Mark Carney warned of the big economic consequences of a no deal Brexit. These economic consequences would force the BoE to reconsider monetary policy. Market participants interpreted this as the central bank lowering interest rates in the case of a no deal Brexit, in order to support a weaker economy.
| Why do raised interest rates boost 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. 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. |
The pound continued to fall as investors feared that Prime Minister Theresa May would be defeated in a Parliamentary vote, but this time by the Remainers. The rebel Remainers plotted to vote with the UK Labour party against May for an amendment to create a customs union with the EU, post Brexit, if frictionless free trade had not been agreed by January 2019. The PM won by 307 votes to 301, sending the pound higher, as political risk receded and Theresa May was able to keep her job another day.
| How does political risk have impact on a currency? |
|---|
| Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money. |
Today, analysts are expecting inflation data to show that inflation ticked higher in June. If so, the pound could move higher as optimism over a rate hike increases.
Fed Chair Boosts The Dollar
The dollar gained ground against its peers on Tuesday as investors digested an upbeat assessment by Federal Reserve Chair Jerome Powell on the health of the US economy. In front of the Senator Banking Committee, Jerome Powell highlighted the growing strength of the US economy and remained confident of the Fed continuing with gradual rate rises. Jerome Powell told the Fed that he was unsure of what the impact of increased trade tensions would be, but this was not impacting on the Fed’s outlook and plans to raise rates. As a result, the dollar rallied across speech and continued to climb once Powell’s appearance had finished.
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