Overview, Knowing the British Pound,

Knowing the British Pound and its influencing factors

High Liquidity

There are two primary reasons for the phenomenal liquidity of the British Pound. First, UK is the one of the top investment destinations after the US, for international investors. All such investments would require conversion of their currencies to GBP. Second, GBP/USD pair is a highly traded currency pair and accounts for 7% of net Forex trade.

Effect of Carry Trades

With the GBP offering very high interest rates, international investors park their funds in the UK after selling their investment in other countries. This is called 'Carry Trade'. A Carry Trade involving purchase of British assets results in appreciation of the GBP.

Effect of difference in interest rates of UK Gilts & international bonds

This is same as the effect of Carry Trade except that in this case, instead of financial market investments, the UK Govt securities (Gilts) are involved. If the interest rate of UK Gilts is higher than German Bunds & US Treasury, then the demand for the Sterling would increase and consequently lead to the rise of the GBP vis-a-vis other currencies.

Forecasting through the 3 month EuroSterling futures

One can come to know about the market expectations on the interest rate of Eurosterling contracts 3 months in future. They are used to forecast the UK interest rates, which consequently would affect the exchange rate of the Sterling.

Effect of comments by politicians on joining EMU

Any indication from influential politicians favouring the adoption of Euro as the UK's currency causes a negative impact on the GBP, causing it to depreciate. This is again because of the Carry Trade effect - foreign investors are hanging on to their British assets only due to its high rate of returns. But, if the Euro, with only 2.75% interest rate is adopted over the GBP with 4%, they would withdraw their funds, causing the sale of their GBP and consequently its depreciation due to fall in its demand.

The Oil Markets

The UK is rich in oil wealth with a contribution of about 11% to its GDP and the GBP tends to appreciate with a rise in global oil prices. This is because the demand for GBP would increase, as more GBP would be required by other countries to buy oil from UK.

The effect of Cross Rates

Any changes in the EUR/GBP conversion rate will affect the GBP/USD conversion rate and vice versa if the EUR/USD rate is maintained constant. This is due to pure mathematical reasons, as the division of EUR/USD rate by GBP/USD must equal the EUR/GBP rate to achieve arithmetic consistency. This phenomenon also leaves traders with opportunities to make easy money by quickly trading the above pairs with momentary inconsistencies until the rates are set right by the markets.

The key Economic Indicators for UK include GDP, Unemployment rate, Balance of Trade, HICP, Retail sales, Consumer's earnings, PPI, & Housing prices apart from BoE Data.

Overview, Knowing the British Pound,