The GBP/USD can be a particularly volatile and unpredictable currency pair. For this reason, the many trading opportunities that such a mobile currency can gift to traders makes it an incredibly popular pair. In terms of its relationship to other major currency pairs it tends to have a negative correlation with the USD/CHF and a positive correlation to the EUR/USD. This means that any significant influences on the prices of either the Euro or the Swiss franc will be reflected and often replicated by the GBP/USD to a certain degree. The GBP/USD could be moving lower in days to come as it fails to move above the key pivot point of 1.5659, however, with the dollar gaining recently on the back of risk aversion, it is interesting to look at what actually influences this volatile currency pair.
Aside from the inter-relational influences between these currencies, the main factor which drives the GBP/USD and has an overall and long term effect on both its general trend and overall value are the disparities between the Bank of England and Federal Reserve interest rates. Interest rates are seen as the key determinant of the relative value of all currencies and are central to affecting their supply and demand. When the governing body of a national or regional bank raise interest rates, it suggests that they are generally attempting to temper inflationary pressures and reduce to level of money in circulation. The theory is that domestically people will save more with the incentive of a higher interest return and, internationally, that the demand for the currency will also increase as a result of this. The demand for the currency rises with international speculators buying the currency to reap the rewards of increased interest rates and thus the value of the currency rises too.
The Bank of England review, and have the power to change, the base interest rate for savings each month. Speculation is often rife on the morning and days prior to this announcement if there is a level of uncertainty as to the decision or if the members of the BOE are seen to be divided on opinion of whether rates should be adjusted. This uncertainty creates both volatility and heightened speculation on the GBP/USD. The intricate interrelation between economic performance and the interest rate means that currency speculators use these decisions to read into the future trend of the GBP/USD with every 0.25% increase or decrease that is decided. For this reason, the overall direction and medium to long term value of the GBP remains dominated by the perception of future economic performance and domestic economic aspirations as decided by the Bank of England.
The GBP does not, however, exist in a bubble and its behaviour is obviously largely affected by that of the USD. If The Bank of England monetary policy can be considered the single largest influence on the GBP alone then this must also be linked to the performance and relative rates of the Federal Reserve. The USD interest rate determines the demand for the dollar and offers an outlook of the future economic health of the world’s largest economy. Trade and economic data, similar to the BOE, drive the FED’s decisions and this is assessed by the global fraternity of speculators in terms of the yield that they will receive. The resulting interest rate differential between the BOE and the FED will affect the value of the GBP/USD through controlling the demand for each.
Tristan Goldthorpe currently lives in Madrid working for an international private sector development consultancy. He completed a postgraduate degree in London two years ago and has since been studying, trading and writing about politics, economics and the forex markets in his spare time. His particular interests are the use of support and resistance to determine price movements and the tendency for markets to become over-extended. Over the past few years he has researched and experimented with different techniques and strategies and now enjoys analysing and discussing potential trade opportunities and fundamental economics.