GBP/USD: Fed Minutes To Drive Direction In Pound Versus Dollar

4 minute read

Despite moving higher in early trade on Tuesday, the pound drifted lower versus the dollar. Brexit optimism sent the pound to a high of US$1.4024, before an improved interest rate outlook sent the dollar higher. The pound US dollar exchange rate closed almost flat on the day just shy of US$1.40.

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.

The pound was in favour in early trade on Tuesday as hopes over Brexit improved. Firstly, a report suggested that the European Parliament was considering offering the UK a privileged access to the single market after Brexit. This would mean that Brexit would be easier on businesses that do trade with the EU, which is more beneficial for the UK economy and therefore 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.

Also providing optimism over Brexit was a speech from UK Brexit Secretary and previous Brexit hardliner David Davis. In his speech, Mr Davis appeared to be looking for a more amicable divorce with the EU and a closer alignment with the EU post Brexit. The UK government still lacks a clear direction and position for Brexit. However, the Brexit cabinet is due to meet on Thursday to put this straight.

Today investors will return to the UK economic calendar, where earning growth data could potentially cause volatility. Analysts are forecasting that UK earnings growth will remain constant and print at 2.5% in the three months to December. Inflation is at 3%, so market participants will want to see that wages are moving higher, taking some of the pressure off household budgets. This in turn would enable consumers to spend more, which is beneficial for the economy and the pound.

US Interest rate expectations continue to increase

The dollar was trading broadly higher in the previous session as the US traders returned from a long weekend. Once again there was little by way for data to drive the dollar. However, the dollar was finding support from general market expectations that the Federal Reserve will need to raise interest rates at a faster pace than they had originally planned.

The minutes from the Fed monetary policy meeting will be released later today. Investors will be watching closely for any clues that the Fed is adopting a more hawkish stance.

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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