US Politics to Drive Dollar Movements Versus the Pound?

TransferWise content team
3 minute read

The pound tumbled 1% versus the US dollar through the previous week, as mixed UK economic data overshadowed a more conservative sounding US Federal Reserve and growing political mayhem in the White House. Moving into the start of the new week the pound was trading at US$1.2880 a level last seen in early July.

Last week UK economic data showed that inflation was easing back and wages were increasing. This essentially removed pressure from the Bank of England (BoE) to raise interest rates any time soon. As the odds of an interest rate hike evaporated, the pound sunk lower.

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.

This week, high impacting economic data is in short supply for the pound, however there are some data points, which could serve to clarify the picture of the UK economy. For example, this morning investors learned that UK house prices dropped 0.9% month on month in August, the largest drop so far this year. This could weigh on sentiment for the pound as it shows that the consumer is wary about spending. Consumers are reining in spending as a result of the squeeze being felt as inflation increases faster than wages. This is bad news for the UK economy, which is so dependent on the consumer spending.

Looking across the week, the main focus, apart from more positional Brexit papers will be the UK GDP figures on Thursday.

US politics still in focus

At the beginning of last week, geopolitical risk eased as tensions between US President Trump and North Korea cooled. This then gave way to domestic political issues for Trump, thanks to his poor response to clashes in Charlottesville. Trump’s response to the Charlottesville incident cost him the support of key business leaders, who resigned from governing councils.

Investors are losing confidence in the Trump Administration’s ability to focus on pushing forward his pro growth economic/tax agenda, when they’re so regularly distracted by Trump’s unpredictable responses to key political tests. This keeps sentiment for the dollar weak

How would Trump’s policies boost the U.S. 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 and, in turn, 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.

Monday will see the start of military training exercises between the US and South Korea, which will no doubt infuriate North Korea. With this is mind US / North Korea political tension could flare up again and keep the mood for the dollar weak. With no major US economic data due for release, any political developments will be closely watched.

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