The pound pushed higher versus the US dollar at the end of last week, taking the exchange rate back above the key level of US$1.30. After a fairly volatile previous week, the pound US dollar exchange rate finished just 0.2% lower. Moving into Monday, the pound continues to push tentatively higher versus the dollar.
Brexit is back in focus for traders of the pound, as UK Prime Minister Theresa May returns from her summer break. Key aspects of the British strategy for Brexit are expected to be released over the coming week in a series of critical papers. These papers are to flesh out where the government is positioning itself in the negotiations and could have significant potential to move the pound. Should there be increased signs of a smooth, transitional Brexit, the pound could benefit.
|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.|
After mildly stronger than expected industrial production data last Thursday, pound traders have had little else to digest in the way of economic data. This will continue to be the case until inflation data on Tuesday.
The US dollar is set for a volatile week as investor will be torn between geopolitical developments and high impacting releases.
Last week was a relatively quiet week as far as influential economic data was concerned. So investors will be keen to digest the details from the latest Federal Reserve monetary policy meeting. The details, released on Wednesday should allow investors to gauge once more the odds of another interest rate hike before the end of the year. Should they indicate an increased likelihood of rates increasing again this year, then the dollar could build on last week’s gains. However, it's worth bearing in mind that the Fed tend to deliver fairly measured statements, devoid of show stopping rhetoric.
|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.|
Currently investors are putting the odds of a rate hike at 38%. Strangely enough, rate hike expectations have actually decreased over recent weeks, despite the US labour market posting stronger data and inflation picking up for the first time in five months. Usually stronger data increases the chances of an interest rate hike.
Newsflow from the White House could throw all of this off course. President Trump and North Korea’s Kim Jong Un sent threats throughout last week, culminating in President Trump floating the idea of a military option on Friday. Fear of war between the two nations has increased flows into safe haven currencies, such as the dollar. Any signs that US Officials are seeking to reduce tensions, could impact on the dollar.
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