The United Kingdom is a land of many accents as it is actually composed of four countries – England, Northern Ireland, Scotland, and Wales.
Headed by the Queen, the U.K. is considered a constitutional monarchy, but is governed through a parliamentary system that is based in England’s capital of London.
The U.K. is also part of the European Union. However, the U.K. has refused to join the euro zone and is adamant about using the pound as its currency. Unfortunately, this means that having a Schengen visa won’t let you travel through the U.K., you’d have to get a separate visa!
United Kingdom: Facts, Figures, and Features
- Neighbors: Ireland, Germany, France
- Size: 94,058 square miles
- Population: 63,047,162 (22nd)
- Density: 670.3 people per square mile
- Capital City: London (population 8,615,000)
- Head of State: Queen Elizabeth II
- Head of Government Prime Minister: David Cameron
- Currency: British Pound (GBP) or sterling
- Main Imports: Manufactured goods,machinery, fuels, foodstuff
- Main Exports: Manufactured goods, fuels, chemicals, tobacco, David Beckham, Simon Cowell
- Imports Partners: Germany 13.1%, China 9.1%, Netherlands 7.5%, France 6.1%, U.S. 5.8%, Norway 5.5%, Belgium 4.9%, Italy 4.2%
- Exports Partners: U.S. 11.4%, Germany 11.2%, France, 7.7%, Ireland 6.8%, Belgium 5.4%
- Time Zone: GMT
- Website: http://number10.gov.uk
The U.K. is the world’s seventh largest economy and the third largest in Europe after Germany and France. As far as history shows us, they’re a force to reckon with. After all, it is Britain that started the Industrial Revolution.
The U.K. also had the world’s largest empire back in the day. So for the past 300 years or so, the U.K. has been a relevant world power. Now that’s what you call consistency!
In terms of trade, England is a net importer of goods with a consistent trade deficit. Its largest trading partner is the euro zone, more specifically Germany, which shouldn’t come as a surprise because Germany is a stone’s throw away across the English Channel.
Trade activity with the euro zone accounts for over half of the UK’s trading activity. The U.S., on an individual basis, still remains the U.K.’s largest trading partner.
Not only do the British have cool accents and hotties like Kate Beckinsale, it is also home to arguably the oldest major financial center in the world. We’re talking about London, boys and girls! Having a financial hub like London amplifies England’s place in world trade.
Monetary & Fiscal Policy
Now here’s a little bit of trivia for all of you: The oldest central bank in the world is the Bank of England (BOE).
Back in the day, when England was on the verge of economic expansion, government leaders realized that they needed an entity to help facilitate international trade. Enter the Bank of England. In 1694, the BOE was founded to help facilitate trade and growth for England.
Today, the BOE’s main monetary policy objective is that of maintaining price stability while at the same time, fostering growth and employment.
As it is, the BOE is aiming for a target inflation rate of 2.0%, which is measured by the consumer price index (CPI). In order to meet this target, the BOE has been granted the magical power to change interest rates to levels that they believe will allow them to meet this target.
The group within the BOE that is in charge of determining interest rates is the Monetary Policy Committee (MPC).
The MPC holds monthly meetings, which are closely followed for announcements on changes in monetary policy, including changes in the interest rate. Like all other things British, interest rates have a different name in England. In England, the interest rate is called the bank repo rate.
The main policy tools used by the BOE’s Monetary Policy Committee are bank repo rate and open market operations.
The bank repo rate is the rate set by the BOE for its own operations in the market to help meet the MPC’s inflation target. Whenever the MPC changes this rate, it affects the rates commercial banks set for their savers and borrowers. This in turn will also affect spending and output in the economy, and eventually costs and prices.
Like other central banks, if the BOE raises the repo rate, they are aiming to curb inflation. On the other hand, if they lower the rate, they are aiming to stimulate growth in the economy.
When the BOE engages in open market operations, the BOE buys and sells GBP denominated treasuries and securities to control the supply of money. This is an alternative method to increase liquidity in the financial markets.
If the BOE feels that there is a need to stimulate the economy, they will “print more money” and inject this into money supply through the purchases of the government and corporate securities.
On the other hand, if the BOE feels like the economy has had enough candy, they will sell more securities, effectively “taking back” money from the economy.
Getting to Know the GBP
The GBP must be pretty popular kid since it has a lot of cool nicknames. Aside from being called the Sterling and the Pound, GBP pairs have awesome nicknames such as Cable (GBP/USD) and Guppy (GBP/JPY). Impressive, huh?
I like to bust a move…
GBP/USD is one of the most liquid currency pairs in the forex market. How come? Remember, London has long been a major financial center in the world. With major business transactions taking place every day, lots of moolah goes in and out of London.
Still, the GBPUSD only accounts for 14% of daily global trades, making it just the third most active pair traded. This is probably the reason why spreads on the GBP/USD tend to be a pip or two more than that of the EUR/USD and the USD/JPY.
… and traders like me because I’ve got some nice curves.
With so many big time corporations being based in London, there are many highly attractive investments to be found in the U.K. market.
Couple this with having some of the higher interest rates (usually) amongst the major currencies, investors may find British securities to be more attractive. In order to get their hands on these assets, investors would first need to purchase some GBP.
I’m nimble during the London session…
GBP/USD trading volume is the highest during the European session, with potential for strong moves during the New York session when key U.K. and U.S. data is released.
The Asian session doesn’t normally provide much movement as European traders are still in bed while U.S. traders have just finished their day.
… but be careful ’cause I can get kinda rowdy!
The GBP pairs are very prone to volatile moves because of its lower level of liquidity compared to that of the EUR.
With liquidity growing thin at certain times in the market, the GBP can get caught in one direction, especially if there are large buy or sell orders in that direction. Compared to other currency pairs, GBP pairs tend to react more strongly to surprise economic data releases.
Important Economic Indicators for the GBP
Consumer Price Index (CPI) – The BOE looks at this account as a measure of inflation. It measures the change in prices of consumer goods.
Unemployment Rate – This is the measure of how many unemployed people there are in the UK economy. Analysts look at this account carefully because it could be a leading indicator of future spending. How come? Well, if a person has no job, he has no money. Without any money, nobody would be able to afford tea time!
Gross Domestic Product (GDP) – This figure reflects the state of the UK economy. It indicates whether the economy is growing and booming, or if it is stuck in the English Channel and drowning.
Purchasing Managers Index (PMI) – This index surveys business managers and asks them their view of the current economic landscape. Scores above 50.0 indicate improving conditions which may lead to expansion, while scores below 50.0 hint at possible contraction.
Gfk Consumer Confidence report -This report gauges consumers’ confidence about current and future economic conditions. The more confident consumers are regarding the state of the UK economy, the more likely that they will be willing to spend.
What Moves the GBP
Changes in Monetary Policy
Many investors look at the pound for higher yielding assets and for carry trade. Changes in the MPC’s interest rate alter sentiment towards the pound as it affects the yield of British securities.
In addition, changes in the bank repo rate also reveal the BOE’s outlook on the economy.
If the BOE officials feel that the economy is hurting, they will either expand quantitative easing measures or cut interest rates, which will signal to the public that the economy is unstable.
If the BOE feels that economy’s rise may lead to inflationary pressures down the road, they may cut back on quantitative easing or hike interest rates.
Developments in the euro zone and US
Like other currency pairs, GBP/USD is also heavily affected by developments in the euro zone and U.S. U.S. economic data directly affect investors and traders sentiment in the market. Good or bad data from the U.S. can either send market participants running to the GBP on increased risk appetite, or looking for safety in the USD on account of risk aversion.
The Spill Over Effect
The euro zone accounts for a majority of the U.K.’s trade relations. Because of this, you should also keep your binoculars ready to see any developments over in the mainland (Remember, the U.K. is an island!). Any bad news or poor economic performance could potentially lead to bearish sentiment towards the GBP.
Driven by Risk Sentiment
Albeit small, the GBP benefits from the fact that it boats a higher interest rate amongst other major currencies. When traders are in search of greater yields, they will look to the U.K. because of the potential of getting a higher return on their investments. When traders want to unwind their high-yielding investments and look for USD-dearest, they will start selling off the GBP.
GBP/USD is traded in amounts denominated in GBP. Standard lot sizes are 100,000 GBP and mini lot sizes are 10,000 GBP.
The pip value, which is denominated in U.S. dollars, is calculated by dividing 1 pip of GBP/USD (for GBP/USD, this is 0.0001) by GBPUSD’s spot rate.
Profit and loss are denominated in U.S. dollars. For one standard lot position size, each pip movement is worth 10 USD. For one mini lot position size, each pip movement is worth 1 USD.
Margin calculations are based in U.S. dollars. For example, if the current GBP/USD rate is 1.5000 and the leverage is 100:1, 1,500 USD is needed in available margin to be able to trade one standard lot of 100,000 GBP. Take note, a higher GBP/USD sport rate requires more USD in available margin, while a lower rate would need less USD for margin.
GBP/USD Trade Tactics
One way to trade GBP pairs is to take note of when key reports come out. GBP pairs tend to react more strongly to economic reports.
For example, if U.K. GDP figures were to come in much better than expected, it could lead to massive rally in the GBP. Even if you were to enter late, you could still grab a bunch of pips because GBP pairs really move a lot.
Be careful though – GBP/USD and GBP/JPY pairs are the most volatile among the majors. In fact, GBPUSD moves around 160 pips per day on average. Because the GBP is so volatile, you might want to set wider stop loss orders to withstand all the strong moves in the market.
Care to have sum mo’ please? Check out Pip Diddy’s daily economic commentary on the U.K.