GBP/USD: Could Brexit Hardliners Limit The Rally In The Pound vs. Dollar?

30.11.17
4 minute read
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The pound moved higher versus the dollar for a second straight session. Sterling is trading at fresh two-month highs against the greenback, hitting a high of US$1.3449.

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 are reassessing the outlook for the UK economy as they begin to get confident that a Brexit deal will be agreed. This comes following Tuesday’s revelation that the UK has agreed to pay the full amount requested by the EU for the financial losses that Brexit might cause. The amount that the UK were willing to pay has been one of the reasons for deadlock in the Brexit negotiations up to now. The removal of this hurdle means negotiations are more likely to move forward to trade and transition talks, making a smooth Brexit more likely.

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.

There are still a couple of key points that the EU wants to see more progress on, such as the Irish border issue. These could come under the spotlight today. Also, there is concern that Conservative Brext hardliners may yet try to vote down over the proposed amount UK has agreed to pay. Headlines pointing to such domestic political issues could limit the pound’s rally.

Will US Inflation Data Pull the Dollar Lower?

The dollar was weaker in the previous session despite signs of strong economic growth. The US third quarter GDP was revised higher to 3.3%, the quickest rate of expansion since 2014. This topped analysts’ forecast of 3.2% and beat the initial estimate of 3% growth. The higher revision shows that the summer hurricanes actually had little impact on the US economy. Delving deeper into the numbers, they show that business investment, exports and merchandise yet be sold, growth in all these areas improved. Interestingly, consumer spending, which accounts for a large percentage of the US economy, eased back from the previous month.

Today sees the release of the US Federal Reserve’s preferred measure of inflation, personal consumption expenditure (PCE). Inflation is proving to be a problem for the Fed. This is because despite the roaring economy and strong labour market, inflation remains low, refusing to tick closer to the Fed’s 2% target. Fed policymakers have expressed concerns over continuing to raise interest rates in 2018 without inflation showing more signs of life. Should PCE read below analysts’ anticipated figure of 1.3%, the dollar could sink lower versus the pound as investors lower their expectations for interest rate rises next year.

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.
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