The pound has shed almost 200 points since its one year high of US$1.3619 reached early on Monday. The sterling rally, which started last week, has quickly lost momentum. Furthermore, disappointing comments by Bank of England (BoE) Governor Mark Carney ensured the pound remained out of favour as the day wore on. The pound finished lower on Monday at US$1.3496.
|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.
Investors focused on BoE governor speech before the IMF in Washington. The UK central bank had said last week that it would be looking to withdraw stimulus in the coming months should UK economic data not suddenly take a turn for the worse. Therefore, investors were keen to hear what more BoE Governor Carney had to offer on the subject. However, markets were disappointed by his comment warning that interest rate rises would be limited and gradual. As a result, the pound tumbled lower.
|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 UK economic calendar is light this week. However, Brexit will be back in the limelight as UK Prime Minister Theresa May is set to take to the stage in Florence on Friday to set out her vision of Brexit. Theresa May isn’t going for the hard Brexit of her colleague, UK Foreign Secretary Boris Johnson. Instead, she seems to be favouring a more smooth, transitional Brexit.
|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.|
A smooth Brexit should be more business friendly. However, it could come with a hefty price tag. There are suggestions that Theresa May will offer £30 billion for the divorce bill in order to kick start stagnating Brexit negotiations. Brexit woes are likely to weigh on sentiment for the pound as the week progresses.
The US dollar is edging higher on general positive sentiment. There’s no specific data which has caused the buck to increase in value, although investors are pleased that tensions are once again cooling between North Korea and the US.
Today is set to be another quiet day as investors await the US Federal Reserve meeting on Wednesday. No interest rate rise is expected from the US, however, dollar traders will be listening hard for any details on plans for US balance sheet reduction. Although this is considered a form of monetary policy tightening, analysts are unsure how the market will respond to the news. This is mainly due to the fact that balance sheet normalization on this size has never happened before.
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