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Pound US Dollar Exchange Rate Recovers Ground Despite Continued Political Risk

October 9, 2017 - Written by Tim Boyer

After seeing considerable weakness over the course of the last week the Pound US Dollar exchange rate was able to recover some of its losses on Monday.

In large part this was thanks to a temporary easing in political uncertainty, with a leadership challenge to Theresa May still yet to properly materialise.

As Viraj Patel, foreign exchange strategist at ING, commented:

‘Talk of a Cabinet reshuffle dominated the weekend press, though the Sunday Times notes that the PM will wait until after the critical Brexit-focused European Council meeting on 19-20 Oct before making any changes to her Cabinet. Still, the tentative show of unanimity within the Cabinet looks to have – at least for now – drawn a line under questions about the PM's leadership. This might help to ease some of the downward pressure on GBP as fears of imminent chaos in Westminster have been thwarted.’

This helped to shore up the GBP USD exchange rate at the start of the week, boosting the pairing even in the absence of any fresh domestic data.

Even so, the Pound’s recovery may struggle to sustain itself for long over the coming days, particularly with the latest round of Brexit talks in focus.

USD Upside Limited Thanks to High Market Pricing of Fed Policy Move

The US Dollar, meanwhile, struggled to sustain its earlier steam even as the general sense of market risk appetite deteriorated.

Weaker Chinese PMIs offered some support to the safe-haven ‘Greenback’, with the appeal of higher-yielding assets diminishing in response to the disappointing data.

However, the upside potential of USD exchange rates appears to be somewhat limited at this juncture thanks to the already-high market expectations for an imminent Federal Reserve interest rate hike.

As analysts at BBH noted:

‘The pricing of December Fed funds futures contract is consistent with around an 80% chance of a hike. The two-year yield is trading at the upper end of what is expected to be the Fed funds target range at the end of the year, after slipping below the current range a month ago. The Dollar Index formed a bottoming pattern.
‘Paradoxically, therein lies the challenge. The anticipation of a hike is now well priced in, and the question is, what now?’

Confidence in the odds of a third 2017 interest rate hike is unlikely to ease even if tomorrow’s NFIB small business optimism index surprises significantly to the downside.

Even so, the contents of the Federal Open Market Committee’s (FOMC) September meeting minutes could provoke an increased bout of volatility for the US Dollar on Wednesday.

If policymakers demonstrate a less optimistic outlook this could weigh heavily on the ‘Greenback’, which remains vulnerable to any dip in the odds of imminent Fed action.

Strong UK Data Could Boost BoE Rate Hike Hopes

Tuesday’s raft of UK production and trade data may encourage the GBP USD exchange rate to extend its bullish run further, if the figures offer fresh evidence of a stronger domestic economy.

Forecasts point towards industrial and manufacturing output having both continued to improve in August, indicating that the sector is still largely shrugging off the negative impact of wider market jitters.

A narrowing of the trade deficit could also give strong support to the Pound, suggesting that the UK economy’s vulnerability to any fresh deterioration in trade conditions is becoming more limited.

On the other hand, any downside disappointments are likely to knock Sterling back onto a softer footing against its rivals.

Focus will also fall on the NIESR gross domestic product estimate for the three months to September, which may boost the odds of an imminent Bank of England (BoE) policy move.

If growth fails to show signs of picking up further, though, the GBP USD exchange rate could slump sharply.

While markets are largely confident that the BoE will return to a tightening bias before the end of the year the optimism of policymakers could still be undermined by weak domestic data.

Any signs that the latest round of Brexit talks are not progressing well could equally weigh on the Pound.
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