The GBP/USD, a.k.a. The Cable, is a major currency pair. It is one of the world’s most heavily traded currency pairs, with the ratio indicating how much £1 is worth in USD. When the ratio indicates a growing value, the GBP is appreciating relative to the USD. When the ratio is decreasing, then the GBP is depreciating relative to the USD. The first currency in the pair is known as the base currency – the British pound.
The second currency is known as the quote currency, in this case the US dollar. The value of the GBP/USD pair is heavily dependent on a host of factors, each of which needs to be considered in isolation, and as part of the bigger picture. In recent years, one of the most divisive elements to impact the GBP and related pairs is the Brexit saga. This years-old ‘hot topic’ issue has receded somewhat after the Tories’ sweeping majority in the aftermath of the December 12, 2019 elections, but is nonetheless a factor to consider when trading the GBP/USD pair.
Focus on interest-rate differentials between the BOE and the Fed
Many novice traders tend to get lost in the minutia when attempting to make sense of currency trading. A veritable glut of information is available in the news media, making it difficult to focus on anything without neglecting the impact of other macroeconomic variables on the currency pair. For simplicity’s sake, one of the most important variables to factor into the equation is interest rates.
Interest rates are monetary policy tools designed to increase or decrease the velocity flow of money through the economy. When central banks increase interest rates, they are attempting to reduce the money supply by enticing investors to deposit into fixed-interest-bearing accounts, thereby removing money from circulation. When interest rates rise in one country, traders from other countries are typically drawn into the picture. They will sell their currency and purchase the currency associated with the increased interest rate.
From a practical perspective, if the Fed raises interest rates and the BOE does nothing, holders of GBP will find it enticing to sell GBP and buy USD, thereby causing the GBP to depreciate relative to the USD, or conversely for the USD to appreciate relative to the GBP. Currently, the US interest rate is 1.75%, the inflation rate is 2.3%, and the unemployment rate is 3.5%. In the UK, the interest rate is 0.75%, the inflation rate is 1.5%, and the unemployment rate is 3.8%. These statistics alone indicate that the UK is adopting an accommodative monetary policy which tends to undermine the real value of the GBP.
Given that interest rates are so low in the UK and the inflation rate is so low, the Bank of England is seeking to accelerate the velocity flow of money to cause the inflation rate to rise towards the 2% benchmark, at which point interest rates will likely rise by 25 basis points. The MPC (Monetary Policy Committee) voted 7/2 to maintain the bank rate at 0.75% when it last met in December. Those in favour of a rate cut are concerned about the job market in the UK and are seeking to make things cheaper to encourage spending.
It is worth pointing out that currency pairs like the GBP/USD do not function in isolation. They are correlated with other currency pairs; sometimes positive correlations exist such as the EUR/USD pair, and at other times, the correlations are negative such as with the USD/CHF pair. The British pound reacts similarly to other major European currencies like the euro and the Swiss franc, that’s why the positive correlation exists.
Economic Calendar of Events
In the case of The Cable (GBP/USD), upcoming economic indicators can have an outsized impact on the value of the trading activity that takes place. These include the following:
Trading Tips to Consider
A myriad of other economic events can have a greater or lesser impact on forex trading activity at any given point. Sometimes, geopolitical events will overshadow economic announcements leading to whipsaw activity in the forex markets. Ongoing Brexit negotiations, US elections, tensions in the Middle East, and natural disasters can shift the needle with Forex trading. There are also technical and fundamental trading tips to take into consideration, allowing for more successful trading sessions, provided the requisite research and due diligence has been conducted. This introductory guide provides a starting point for GBP/USD traders entering the $5 trillion + per day currency trading arena.