In this article we are going to look at the British Pound, the world’s oldest, still used currency. We will explore the Pound in a historical context, looking at its roots in the Forex market, we will follow the Pound into the modern era and on into the recent Brexit saga. We will also look at the events that can impact the Pound on a day to day basis and in the longer-term, and also what lies ahead for the U.K.’s currency.
- What is Forex?
- The Pound defined
- What impacts the GBP Forex rate?
- The Pound in a historical context
- GB Pound in the modern era
- The Pound in the Brexit era
- The future for Sterling
What is Forex?
Forex Market Definition: A market to exchange one currency for another for immediate or future delivery.
Before we can take a look at the GB Pound specifically, we should first place the Pound in the context of the financial market that we are looking at, the Forex market. The Forex markets are also called FX, foreign exchange and currency markets. They are non-centralized, global markets for trading different currencies. You can see our broad History of the Forex Markets here which should help with the historical view of how the Foreign Exchange markets developed.
Trading forex comprises buying one currency and simultaneously selling another. The primary centre of the FX Market has been London since the end of Bretton Woods given its central geographic position. Forex is traded over the counter (OTC) and on exchange (FX futures after traded on the Chicago Mercantile Exchange (CME)). It features a large turnover, between $5 and $7 trillion per day and is very liquid, meaning that two-way prices are available, and it is relatively easy to open and close market positions.
The FX market is global and is a 24-hour market, 5.5 days a week (opening in Asia on Monday morning and closing in the US on Friday evening). It also has low margins, tight spreads and a large scope and variety of participants. These would include; Central Banks, Investment Banks, Multinational Companies, Hedge Funds, Investment Managers, FX Brokers, Importers and Exporters, speculators/ leveraged Retail Investors.
The Pound defined
The Pound is the common name for the currency of the United Kingdom (U.K.), which is officially known as Pound Sterling, sometimes just Sterling.
In Forex terms its ISO Code is GBP. The Pound is the fourth most traded currency globally on the Forex market, after the so called G3 currencies, the US Dollar the Euro and the Japanese Yen. Alongside these three currencies and the Chinese Yuan, the Pound makes up the five currencies that input into the calculation for the International Monetary Fund Special Drawing Rights. Furthermore, the Pound comes in at number five on the list of currencies held in global reserves. The symbol for the Pound is £, which derives from the letter L, from the Roman word libra, meaning pound (in weight).
In Forex markets, the Pound against the US Dollar exchange rate is often referred to as “Cable”. This comes from the fact that in the 1800s the GBPUSD Forex rate was transmitted between the US and U.K. via a transatlantic cable.
What impacts the GBP Forex rate?
The five main factors influencing the short-term value of the Pound (GBP) in Forex markets are:
- U.K. economic conditions and data
- Global economic conditions and data
- U.K. interest rate moves and expectations
- Interest rate differentials
- Geopolitical influences
A stronger U.K. economy, or the perception of a stronger economy as indicated by short term economic data has a direct influence on the currency, with an improving economy encouraging a stronger Pound. Conversely, a weakening economy or weaker economic data tends to lead to a weaker Pound. Furthermore, changes in the global economic outlook can also impact on the Pound Sterling, though these impacts can sometimes be difficult to predict and will depend upon the relative position of the U.K. economy, in relation to the global economic backdrop.
In addition, the level of U.K. interest rates, which are set by the U.K. central bank, the Bank of England also impact on the value of the Pound in Forex markets. It tends to be the case that higher interest rates, or the perception of higher interest rates will lead to an appreciation in the Pound. Conversely, a lowering of interest rates or the expectations of interest rate cuts will tend to see a depreciation in Sterling on Foreign Exchange markets. Therefore, monitoring the activity of the Bank of England alongside speakers from the Monetary Policy Committee (MPC) of the Bank of England, is essential in understanding movements in the Pound on currency markets.
In addition, all Forex market are relative value, that is to say one currency is exchanged for another currency. This means that the differential between U.K. interest rates and interest rates of other countries influences the level of the Pound against those other currencies.
Finally, geopolitical impacts from the likes of politics, trade wars, terrorism and the weather can impact all global financial markets, with the Foreign Exchange markets and the Pound no exception.
In the longer term, the Pound Sterling’s value is impacted by:
- The longer-term U.K. economic condition
- The longer-term global economic condition
- Long-term geopolitical shifts
The longer-term influences on the Pound are similar to the short term influences, but we would be looking at the longer-term shifts in the U.K.’s economic outlook and also the longer-term global conditions. In addition, bigger picture, structural geopolitical shifts could have an impact on the Pound’s value against global currencies.
The Pound in a historical context
We have produced a comprehensive History of the Forex Markets here, which you should read to give an understanding of where the Pound sits in the broader framework of Forex Markets. As the planet’s oldest still used currency, the Pound has seen the comings and goings of The Gold Standard Monetary System, the Bretton Woods System, the Smithsonian Agreement, the Plaza Accord, the European Exchange Rate Mechanism, the birth of the Euro and the Brexit divorce from the EU.
In this section, however, we are going to look more specifically at the historical context for the Pound from ancient times to decimalisation in the early 1970s.
The Pound dates back to the 8th Century, back to Anglo-Saxon times, where 240 silver pennies was the equivalent of one pound in weight of silver. This then developed into the current U.K. currency, the Pound Sterling, from the weight of the Sterling Silver. Silver was the legal basis for the currency until 1816, though during Tudor times the silver coins were debased on a number of occasions. From 1816, the Gold Standard was officially adopted, with the Bank of England issuing legal tender notes valued relative to gold.
The Pound was used extensively on a global basis during the 18th and 19th Centuries as the British Empire grew. In Canada, Australia, India, the Caribbean and South Africa. The Gold Standard was suspended at the start of World War One in 1914, with a new version reinstated 1925, but then abandoned in 1931 during the Great Depression.
During World War Two, in 1940, the Pound was pegged to the US Dollar, at $4.03, eventually devalued in 1949 to $2.80.
GB Pound in the modern era
The Pound has also been on a rollercoaster in the more modern era, which really kicked off with decimalisation on 15th February 1971. After the move to a decimal system, the Pound then went on to free float against global currencies from August 1971 after the breakdown of the Breton Woods System. Sterling then managed to ride out the 1976 Sterling Crisis, then an aggressive rally and selloff in the Thatcher era of monetary policy that saw GBPUSD rally to $2.40 in 1979 and plunge to $1.03 in 1985.
Then saw a move to shadow the German Mark from 1988 and then shadow the European Currency Unit (ECU) as part of the European Exchange Rate Mechanism (ERM). However, the Pound crashed out, leaving of the ERM on Black Wednesday, 16th September 1992 after aggressive speculation against the Pound, famously by the speculator George Soros.
The U.K. government then decided to opt out of adopting the Euro, which fully came into being on 1st January 1999. The Pound also suffered during the first part of the 2008-2009 global financial crisis, plunging in value against both the US Dollar and Euro.
The Pound in the Brexit era
On the 23rd June 2016 the U.K. European Union Membership Referendum took place, now commonly known as the Brexit vote. The result was for the U.K. to leave the European Union, which immediately established a new era for the Pound’s relationship with global currencies. The Pound immediately weakened against the Euro by 5% with GBPEUR moving from 1.30 down to 1.23, then by October lower to 1.1450, a 14% depreciation. On the same timelines, the Pound versus the US Dollar, the Cable Forex rate (GBPUSD) went from 1.46 to 1.37 overnight and to 1.22 by October 2016, a 16% decline.
Since then Cable has been in a broad, erratic range, effectively contained between 1.19 and 1.43, reacting to the numerous positive and negative Brexit scenarios as they have developed throughout the whole Brexit saga.
The future for Sterling
The short-term future for the Pound is unclear, though the risks for latter 2019 are currently more skewed towards a more negative tone for the currency versus the US Dollar and Euro. The new Brexit deal that has been agreed between the U.K. and EU points to less risk of a “no deal” Brexit, with hope for a manageable transition. However, into the 12th December UK general election, we anticipate a new set of uncertainties.
In the medium-term, the threat is for the current global slowdown to extend into 2020 and potentially for recessionary pressures in the U.K. and globally. This could increase difficulties for the UK government and the economy, particularly whilst attempting to negotiate new trade deals (given that Brexit occurs).
In the very long run, clearly there is a significant divide in the U.K. amongst the electorate, the politicians and also amongst strategists and economists as to whether the U.K. will thrive outside of the EU, or potentially suffer. Only time will tell!
In this article we have reviewed what the foreign exchange market is and what the Pound Sterling is. We have also explored what it is that impacts on the value of the Pound against other currencies on Forex markets and looked at the U.K. currency in a historical context, during the modern era and during the current Brexit phase. As for the future for the Pound, one thing is almost certain, it will NOT be dull!