The Overview of British pounds (GBP)
The UK, the world’s fourth-largest economy with the most efficient central bank globally, has long benefited from high growth, low unemployment, increased output, and a recovery in consumption.
Britain is a service-oriented country, with the manufacturing sector accounting for less GDP and now accounting for one-fifth of its production. Meanwhile, It has one of the most advanced capital market systems globally, and the financial industry is the most significant contributor to the UK’s GDP.
Although the service industry accounts for most of the GDP, we should not overlook that Britain is one of the largest natural gas producers and exporters in the EU. Energy production accounts for 10 per cent of the UK’s GDP, the highest among developed countries. Rising energy prices, such as oil prices, are critical because they bring significant British oil exporters returns.
Overall, the UK is a net importer with a continuing trade deficit. The largest trading partner is the EU, and bilateral trade accounts for more than 50% of the UK’s total imports and exports. As a single country, the United States is Britain’s largest trading partner.
BOE Determines Monetary Policy
The nine-member Monetary Policy Committee consists of the president, two vice presidents, two BOE directors, and four outside experts, determining the monetary policy. The Commission approved the independence of monetary policy operations in 1997.
Despite this independence, BOE’s monetary policy focuses on achieving inflation targets by the Minister of Finance. BOE has the authority to adjust interest rates within its permissible range to accomplish this goal. The Monetary Policy Committee shall determine changes in monetary policy, including changes in interest rates, through monthly meetings and announce the details thereof.
The Monetary Policy Committee states all meetings, along with a quarterly inflation report describing the Monetary Policy Committee’s outlook on growth, inflation and legitimacy of policy changes over the next two years.
Other quarterly publications provide information on analysing the past monetary policy movements, the international economic environment, and the impact on the UK economy. All reports include details of the Monetary Policy Committee’s policies and future policy movements.
The primary means of the policy used by the Monetary Policy Committee and the Bank of England are as follows:
1. Bank Repo Rate
This is the primary interest rate used to implement monetary policy that meets the treasury’s inflation target. This interest rate is set for banking operations in markets such as short-term loans from banks.
Change in interest rates affects interest rates charged by commercial banks for depositors and borrowers. This will affect economic spending and production, and consequently, costs and prices—the rise in interest rates to lower inflation will stimulate growth and expand the economy.
2. Open Market Manipulation
Open market manipulation is implemented by adjusting the repo as mentioned above rates and ensuring adequate liquidity in the market and continuous stability in the banking system.
This reflects the Bank of England’s three main objectives: maintaining the value of the currency, maintaining the strength of the financial system and securing the efficiency of UK financial services.
BOE implements open market manipulation that controls liquidity by buying or selling short-term bonds every day. If this is not enough to manage liquidity, BOE can perform additional Overnight operations.
The Main Characteristics of the Pound
1. GBP/USD is highly fluid.
GBP/USD is one of the most volatile pairs of currencies, with the British pound accounting for 6% of all pound-related foreign exchange transactions in the world, the benchmark or relative currency. It is also one of the four most volatile currency pairs (EUR/USD, GBP/USD, USD/JPY and USD/CHF) in the foreign exchange market.
One of the reasons for the high liquidity of GBP/USD is the highly developed UK capital market. Many foreign investors who sought investment opportunities outside the United States have invested money in the United Kingdom. Foreigners must sell their currency and buy British pounds for British investment.
2. GBP has many speculators.
The British pound was one of the currencies with the highest interest rates among developed countries. Interest rates in Australia and New Zealand are higher, but their financial markets are not as advanced as in the UK.
As a result, many investors who already have positions or are interested in new carry trading positions have sold currencies such as the U.S. Dollar, Japanese Yen, and Swiss Francs and purchased GBP as relative currency.
Carry trading is to sell or borrow low-interest currencies to invest in high-interest currency assets or manage loans. In recent years, demand for pounds has increased as carry trade has become more common. However, if the interest rate difference between the pound and other currencies decreases, the liquidation of the carry trade will increase the volatility of the pound.
3. Difference in interest rates between British and foreign government bonds.
The difference in interest rates between UK & US government bonds (leading indicators of GBP/USD) and UK & German government bonds (leading indicators of EUR/GBP) are indicators that participants in the forex market consider.
This difference in interest rates can determine to what extent the premium of UK bonds is higher than or vice versa for US and European bonds. German bonds are used as barometers of European interest rates. These differences offer a signal of potential capital flows or currency movements for traders. Currently, the British currency has the same credit stability as the United States.
4. Euro-Pound futures provide a sign of interest rate movement.
It is vital to keep an eye on the potential changes in interest rates as UK interest rates or bank repo rates are used as a significant policy means for monetary policy. Government officials’ remarks are becoming a way to capture changes in interest rate trends. It is also releasing the vote results by members of the Monetary Policy Committee of the Bank of England.
Announcing the results of a committee member’s vote means that their opinions are not those of the Bank of England but personal. Therefore, it is necessary to look for other signals to predict potential changes in bank interest rates.
The three-month euro futures reflect market expectations for the next three months of the euro. These indicators help predict changes in UK interest rates and ultimately affect GBP/USD’s movement.
5. British politicians’ remarks about the euro affect the euro.
Comments on the euro (especially those made by the prime minister or finance minister) or opinion polls impact the foreign exchange market. A fall in interest rates would lead to the liquidation of the position of carry traders.
The British economy has now grown well under the supervision of monetary authorities. EMU is currently experiencing many challenges due to participating countries that do not meet the convergence criteria for EMU membership.
For the ECB, a single monetary authority, to govern (19 countries, including the UK), the EMU must create a monetary policy that can coordinate all the affected countries’ economic situation.
6. GBP has a positive link to energy prices.
Britain has the largest energy companies in the world. Energy production accounts for about 10% of the UK GDP, and as a result, the UK pound correlates with energy prices. Many EU countries import crude oil from the UK, so if oil prices rise, they will eventually have to buy more pounds to finance their energy purchases. Rising oil prices will also boost profits for British energy exporters.
7. GBP Cross Call
The GBP/USD currency pair tends to be more sensitive to the U.S. economy. However, both currencies are interdependent. This means that the movement of EUR/GBP can permeate the movement of GBP/USD, and vice versa.
The movement of GBP/USD can also affect EUR/GBP transactions. Thus, pound traders should consciously watch the trends of both pairs of currencies.
The EUR/GBP exchange rate should be the same as dividing EUR/USD by GBP/USD. Market participants often engage in arbitrage using slight differences between exchange rates, so these differences disappear very quickly.
Important Economic Indicators in the UK
The following economic indicators are all important indicators of the United Kingdom. However, since the UK is a service-oriented economy, it is better to focus on figures, especially the service sector.
1. Employment
England conducts the monthly survey. The survey aims to classify the workforce into three groups – employed, unemployed, and non-labour – and provide detailed data on them.
The survey data provide market participants with critical information about the labour market, such as the industry-specific employment movement and the unemployment rate of working hours.
2. Retail Price Index
The retail price index RPI is an indicator of the price movement of the consumer goods basket. The traders watch RPI or RPI-X except for mortgage interest payments. The Treasury Department uses the RPI-X for price targets.
3. GDP
The quarterly report investigated by the Bureau of Statistics is the total value of all goods and services produced in the UK. GDP is calculated by adding net foreign purchases to household, business and government spending.
The GDP deflator is used to convert gross output measured at current prices to fixed-dollar GDP for the base year. High growth rates are often interpreted as inflation, and low (or negative) growth rates suggest economic recession or sluggish economic growth.
4. Industrial Production
Industrial production, IP Index, measures production changes in the UK’s manufacturing, mining, quarrying, electricity and water supply industries. Industrial production surveys the physical quantity of products, not sales, and multiplies the price to produce. Because IP accounts for one-quarter of GDP, we can understand the current economic situation.
5. Purchase Manager Index
The Purchasing Managers’ Index (PMI) is a monthly survey published by the British Purchaser Association, a weighted average of seasonal factors for production, new orders, inventory and employment items. Above 50 means the expansion of the competition, and below 50 means the contraction of the competition.
6. The Number of UK Housing Construction
The number of housing construction projects is a survey of the number of residential building projects constructing. The housing market is an important indicator because it is a significant industry that sustains economic growth.