On Monday, the pound proved just how politically driven it is. Sterling gained versus the US dollar despite UK business optimism dropping to its lowest level in a year. After a slow start for the pound in the previous session, it reversed losses in the afternoon, moving higher versus the strong dollar. The pound US dollar exchange rate finished over 0.1% higher at US$1.3197 .
|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.
Data on Monday from the Confederation of Business Industry (CBI) showed UK business optimism dropped from -5 to -11 in the three months to October. This is the lowest level in over 12 months, undermining optimism in the outlook for the UK economy. Usually, poor data sends the pound lower.
|Why does poor economic data drag on a country’s currency?|
|Slowing economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.|
However, the pound picked up sharply as UK Prime Minister Theresa May discussed the momentum in Brexit talks when she appeared in UK Parliament on Monday. Investors are increasingly hopeful that Brexit negotiations will progress to transition deal and trade deal talks before the end of the year. Theresa May boosted these hopes by saying that the country is “within touching distance” of moving onto the next stage of the negotiations. The pound rallied as hopes of a smooth Brexit increased.
|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.|
Meanwhile, the outlook for the dollar was also strong, albeit slightly weaker than the pound. The dollar showed strength on Monday, as investors continued to cheer the increased likelihood of Trump’s pro-growth tax reform being pushed through. The tax reform would include a clause that would enable US firms to repatriate money held overseas, encouraging them to bring this money back into the US. This would boost the demand for the dollar which is why the dollar rallied.
The US economic calendar was quiet in the previous session. However, today sees the release of manufacturing and service sector activity data. Analysts are expecting both sectors to report an increase in activity since last month. Should this be the case then the dollar could rally higher.
Meanwhile, investors are still awaiting President Trump’s choice to replace Federal Reserve Chair Janet Yellen. Yellen’s term finishes in February next year and her replacement is expected to be announced over the coming days. Should the market consider the new Chair to be more conservative than Yellen, the dollar could then fall. However, if the Fed chair is replaced by someone considered aggressive in financial policy, that would see the dollar climb.
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