Pound and Dollar Both Driven by Politics At The Start Of A New Week

04.12.17
4 minute read
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Last week saw the pound rally over 3% versus the dollar, pushing the exchange rate to a high of US$1.3550 for the pound. However, weakness crept into the pair on Friday, resulting in the pound US dollar exchange closing 0.4% lower during end of the day.

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.

Politics were the main driving force behind the pound last week and this week is expected to be the same. Reports that UK Prime Minister Theresa May was has offered the EU’s full asking price for the Brexit divorce bill has boosted sterling. The divorce bill is an amount that the EU wants UK to pay to cover for financial losses that Brexit might cause. This is because it cleared one of the biggest obstacles to progressing to trade and transition deal discussions. These 2nd phase talks could help pave the way for a smooth Brexit, which is beneficial 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.

Today, Theresa May is due to meet with the President of the European Commission, Jean Claude-Juncker and EU Chief Negotiator Michel Barnier. Theresa May will present her final offer, and hopefully end the 1st phase of Brexit talks. This gives EU officials time to consider the offer before a key EU summit on 15 December.

Investors are preparing themselves to buy into the pound, should Theresa May deliver an offer to Brussels that cements a UK transition deal with the EU. However, if talks break down and hopes of a smooth Brexit decline, the pound could plummet.

Political Risk Returns As Trump-Russia Inquiry Gathers Speed

Politics have been equally important in driving the US dollar in recent sessions. Finally, early Saturday morning, the Senate approved their version of the US tax reform bill. A bill which is the most sweeping overhaul of the US tax code in decades and which represents President Trump’s first legislative victory. The bill will now move to the conference committee before appearing on President Trump’s desk. News that the bill is nearing implementation should boost the dollar.

How would Trump’s policies boost the US dollar?
A sizeable corporation tax cut would see a flood of money repatriated to the USA which would then create a high demand for the currency. In turn, this would increase its value versus other currencies. Infrastructure spending in a country already close to full employment would also push wages higher, leading to more spending and thus boosting inflation. Higher inflation leads to higher interest rates and a higher demand for the currency.

However, there are more political headlines, which could also weigh on the dollar as the new week kicks off. Developments in Special Counsel Robert Mueller’s inquiry into alleged Russian interference in the US elections could unnerve dollar investors as the new week kicks off. A former top aide for Trump, Michael Flynn, has entered into a plea deal, which increases exposure of senior Trump team members. Investors will be considering how much damage can this do to President Trump.

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