GBP/USD: UK Retail Sales, Brexit & Who Next at the Fed?

20.10.17
4 minute read
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The pound US dollar exchange rate fell on Thursday. Weak UK retail sales data muddied the water over whether the Bank of England would raise interest rates. As a result, the pound US dollar exchange rate fell 0.3% across the day for sterling to close at US$1.3160.

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.

UK retail sales dropped by 0.8%, well below the 0.1% increase analysts had forecast and also well below August’s increase of 0.9%. The figures show that the UK consumer is feeling squeezed, as the cost of living is running higher than wage growth. Spending on discretionary items, such as fashion goods, has taken a particularly big hit, as consumers prioritise essential items.

Analysts had been expecting the Bank of England (BoE) to raise interest rates at its next monetary policy meeting in November. However, investors are starting to doubt whether the central bank will be able to actually make the hike, given the weakening economy. As the odds of an interest rate hike decreased, so did the value of the pound.

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.

Brexit news also weighed on the pound on Thursday. The two sides appear to have made little progress over five rounds of negotiations, with each side criticising the other for their lack of flexibility. The lack of progress means the possibility of a hard Brexit is increasing. This would be a Brexit where no deal is reached and is not a favourable outcome for the pound.

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.

Who will follow Yellen as US Fed Chair?

In the US, investors are keeping an eye on who will replace Janet Yellen as the US Federal Reserve Chairperson. Yellen is set to complete her 3-year term in February next year. While Yellen is apparently quite keen on a second term, President Trump appears to have other ideas. The 3 candidates on Trump’s shortlist are Jerome Powell, Kevin Warsh and John Taylor. Taylor is considered the more hawkish; in other words, he’s the candidate most likely to push interest rates higher, quickly.

While Taylor had been the favourite, according to a report in Politico, Powell now looks set to take the position. Analysts consider Powell to be a continuation of the Bernanke-Yellen era, with similar policies and approach. Since he’s considered more conservative than the previous favourite, Taylor, the dollar, as a result, then remained subdued in trading on Thursday.

Looking ahead across today, the dollar may find itself under pressure once again. The focus will rest squarely on Fed Chair Yellen who speaks later. So far, the Fed is expected to raise rates in December. Should Yellen continue to sound doubtful over the path of rate hikes in 2018, the dollar could then drop.

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