Pound Weakens Even As Dollar Struggles Due To EU's Reaction on Trump's Tax Plan

12.12.17
4 minute read
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The pound took another step lower against the dollar on Monday as Brexit continues to weigh on sentiment, despite a Brexit deal being agreed. The pound US dollar exchange rate slipped to a low of US$1.3336 for the pound, as the pound was unable to capitalise on the weak dollar.

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.

Sterling has not been able to put in a positive performance since the Brexit divorce bill was announced early Friday morning. EU Chief negotiator, Michel Barnier, said that trade talks can’t begin until February, at the earliest. This is making investors nervous that there isn’t enough material time to complete a trade agreement. No trade agreement means that the UK will leave the EU on a hard Brexit. This cliff edge style Brexit would be disastrous for UK business, the UK economy and 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.

Today investors may turn their attention away from Brexit developments towards economic data. Inflation, as measured by the consumer price index is due to be released. Analysts are expecting inflation to have remained steady at the five year high of 3%, in November. Should the reading show that inflation is continuing to tick higher, the pound could rally on hopes of the Bank of England looking to raise interest rates again 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.

Will EU Ministers’ Warning Over US Tax Reform Slow Its Progress?

The dollar started the week off on a weaker note, falling against most its major peers except the pound. After the dollar rallied hard across the previous week on tax reform news, developments on Monday were not so encouraging. EU finance ministers warned Trump that his planned tax reform is “at odds” with the international free-trade rules. This is because it could be discriminatory against foreign trade companies. It could be going against World Trade Organisation (WTO) principles, in addition to double tax resolution. Given how set President Trump is to push the new Tax reform bill through, this warning may not have any impact. However, it has caused some concern to investors, which is resulting in the dollar falling.

With no high impacting US economic data due today, investors will continue to listen intently for progress in the tax reform as it makes its way through congress. Attention will also move towards the Federal Reserve, which is due to take it monetary policy decision on Wednesday.

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