GBP/USD: Risk Aversion A Key Theme as Geopolitical Tensions Rise Again

3 minute read

Hopes of a softer Brexit and lacklustre demand for the dollar amid renewed geopolitical tensions helped the pound US dollar exchange rate charge higher in the previous session. The pound surged from a day’s low of US$1.2874 to US$1.2940, a level last seen two weeks ago.

Despite the UK August bank holiday, the pound was one of the top performing currencies on Monday. The pound received its latest boost after the UK Labour Party leader Jeremy Corbyn made a U-turn regarding his stance towards the single market, shifting towards a “softer” Brexit stance. In doing so the UK Labour leader is creating an unusual alliance with the Treasury in seeking a business-friendly Brexit. This new position from Labour could allow it to exploit the division in the Tories over Europe. The next few months promise to be very challenging for UK Prime Minister Theresa May and could lead towards a softer Brexit, which would be beneficial for 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's 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.

Third round Brexit negotiations begun again on Monday and headlines last night pointed to a challenging start. The EU are quite clear that more progress must be made on the divorce topics particularly those relating to cost and citizens’ rights before future relationships can be discussed.

Recent papers published by the UK government have pointed to a slight softening of stance and this is encouraging. However, diplomacy surrounding a transition period and any exit bill remain fraught. With no high impact UK economic data due to be released today, investors will continue to digest the Brexit headlines as the come out of Brussels.

Geopolitical tension heats up as North Korea fires a missile over Japan

The US dollar traded lower against all its major peers on Monday. Losses for the dollar were further extended after North Korea fired a missile over Japan. At the time of writing President Trump was yet to respond but it's safe to assume that he won’t be happy with the action.

Risk aversion looks set to be the key tone for trading across Tuesday. The US dollar is often considered a safe haven currency, in other words, a currency that investors look towards in times of geopolitical tensions. However, given that the tensions lie with the US, investors could look to ditch the dollar in favour of other safe haven currencies such as the Swiss Franc or the Japanese yen (although proximity is also an issue for Japan).

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