GBP/USD: Brexit & Trade Tariffs Weigh on Pound vs. Dollar

05.03.18
4 minute read
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The pound made small gains against the dollar on Friday as politics on both sides of the Atlantic drove trading. The pound US dollar exchange rate ended Friday 0.2% higher at US$1.3800. However, on a weekly basis the pound was still over 1% lower versus the 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.

Brexit was a central theme for the pound across the previous week. Market participants have grown increasingly nervous that the UK and the EU will not manage to arrive at a post Brexit transition deal. There is still a significant distance between the position of each side and with time moving quickly they might not find sufficient common ground. No transition deal means a hard Brexit is more likely.

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.

On Friday Theresa May made a landmark speech on her vision of what the post Brexit UK -EU relationship should look like. This was a much-anticipated speech; however, it lacked the detail that investors were hoping for. The EU has accused the UK of being unclear in what they are aiming for and this speech was evidence of the lack of anything concrete or solid from the UK.

With little in the way of high impacting economic data this week, investors will remain focused on Brexit developments, or the lack thereof. Market participants will be particularly keen to see any evidence that talks are moving forwards.

Dollar Drops On Trade War Concerns

Despite rising strongly at the beginning of last week, the dollar wiped out most gains at the end of the week. Demand for the dollar declined as investors reacted to President Trump’s announcement of a 25% tariff on steel and a 10% tariff on aluminium. Allies including Canada and the UK will have to pay, in addition to competitors such as China.

Market fears that Trump’s actions would start a trade war were aggravated by a tweet by Trump saying that “trade wars were good”. Investors are concerned that retaliation from China or Europe could start a trade war which would be bad news for the dollar.

How does political risk have impact on a currency?
Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.

In the absence of any further news over the tariffs, investors will look towards high impacting service sector data to provide further clues as to the health of the US economy

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