Pound Struggles on UK Political Woes, Australian Dollar Damaged by Chinese Slowdown

05.06.17
4 minute read
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The pound strengthened against the Australian dollar for most of last week. Fears over a slowdown in China weighed more on the Australian dollar than concerns over the UK general election weighed on the pound.

By the end of the week the pound Australian dollar exchange rate had pushed to a high of A$1.7492, before moving lower to finish the week at A$1.7325. The rate continues to hover around its highest level for the pound since September last year.

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 = 1.72119 AUD
Here, £1 is equivalent to approximately A$1.72. This specifically measures the pound’s worth against the Australian dollar. If the Aussie dollar amount increases in this pairing, it’s positive for the pound.
Or, if you were looking at it the other way around: 1 AUD = 0.57677 GBP
In this example, A$1 is equivalent to approximately £0.58. This measures the Australian dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the Aussie dollar.

The big event for the pound this week is without any doubt the UK general elections on 8th June. When UK Conservative leader Theresa May called the elections, she was expecting a landslide victory. However, the latest polls show that the Labour party, led by Jeremy Corbyn, is now just one point behind the Conservatives according to one poll. Failure by Theresa May to increase the Conservative’s majority in Parliament is expected to weaken Theresa May’s position in the Brexit negotiations, which would be pound negative.

Worse still, a hung Parliament is suddenly looking very likely. A hung Parliament, whereby neither the Conservatives or Labour win by a sufficient working majority, would mean a coalition government is required. This in itself creates uncertainty as to which parties would be willing to form a coalition government and under what terms. A coalition government also creates a cloudy outlook for Brexit, possibly affecting the chances of a smooth Brexit, which is also bad news for the pound.

Why is a smooth Brexit good for the pound?
A smoother Brexit would be a scenario in which the economic consequences of leaving the European Union are minimised. This is favourable for the pound because the less the Brexit impact on the economy, the more likely that foreign investors will remain interested in the UK. Foreign investors need sterling to invest in the country and so the more GBP is purchased, the higher the demand and, thus, an increase in the currency’s value.

Todays’ service sector data to be released is expected to be overshadowed by the UK election race.

A neutral RBA will keep focus on concerns over iron ore prices and China

The pound is certainly suffering, but it appears that the Australian dollar has problems of its own. Australia’s largest export, iron ore, has been steadily losing value over the past 7 months which, in turn, is negatively affecting the Australian economy. Furthermore, China, Australia’s largest export partner is experiencing a slowdown in growth, affecting its demand for iron ore and other materials from Australia. A weaker Australian economy attracts less foreign investment and, therefore, there is less demand for its currency. This is keeping the Australian dollar’s value subdued, which is what has been seen over recent months.

What’s the link between China and the Australian dollar?
China is Australia’s principal trading partner and the world’s largest consumer of metals. Commodities, particularly iron ore, make up the bulk of Australian exports. Australian iron ore needs to be purchased using Australian dollars. So, if the demand or expected demand for the iron ore decreases because China’s economy looks like it may be slow, the price of the metal normally lowers in response. Thus, the demand for Australian dollars will also go down, devaluing the currency.

Looking ahead to this week, the Reserve Bank of Australia (RBA) is due to meet on Tuesday to set Australia’s interest rate. The central bank isn’t expected to make any changes to the rate and should remain neutral. A neutral stance should not impact on the Australian dollar.

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