An Introduction to the British Pound (GBP)

The British Pound (GBP) or Pound Sterling is the national currency of the United Kingdom, and its code in the FX market is GBP. It is the fourth largest circulating currency in the world, after the US Dollar, the Euro, and the Japanese Yen.

In the global FX markets, the GBPUSD is also one of the top currency pairs, with considerable market liquidity. The pair comprises the official currencies of the world's largest economies, the British Pound and the US Dollar.

The GBP is the fourth-most traded currency in the world. It is the official currency of the United Kingdom, the world’s fifth-largest economy. The Bank of England issues it with the symbol '£’.

The USD is the most traded currency in the world. It is the official currency of the world's largest economy, the United States. The Federal Reserve issues it with the symbol ‘$’.

The symbols GBPUSD or GBP/USD are used when trading FX quotes in the FX market or CFDs.

The US Dollar Index (DXY), trading on the Intercontinental Exchange (ICE), is a comprehensive measure of the US Dollar's exchange rate in the international FX market. It reflects global capital outflows and inflows into the US dollar.

The weight of the six major international currencies and their proportion in the US Dollar Index is the Euro (57.6%), the Japanese Yen (13.6%), the British Pound (11.9%), the Canadian Dollar (9.1%), the Swedish Krona (4.2%), and the Swiss Franc (3.6%). Therefore, the Pound Sterling accounts for the fourth place, and it can easily affect the US Dollar exchange rate in case it experiences severe fluctuations.

The most important factors influencing the exchange rate of the British Pound are the policies of the Bank of England (BoE) and the Monetary Policy Committee.

In addition, it also includes the GBP interest rates, government bonds, and the FTSE 100 index, among others.

BoE monetary policy

Since 1997, the Bank of England has had an independent role in developing monetary policy. However, this monetary policy still needs to comply with the inflation standards set by the government.

Interest Rate

The interest rate is the minimum lending rate (the base rate) set by the central bank; changes in the interest rate usually impact the Pound significantly.

The Monetary Policy Committee (MPC)

The Bank of England’s Monetary Policy Committee is responsible for making decisions about Bank Rate. If most members support an increase, rates will likely rise at the MPC meeting. If not, rates may decrease, or rates might be held stable. The Monetary Policy Committee (MPC) is made up of nine members: the Governor, the three Deputy Governors for Monetary Policy, Financial Stability, Markets, and Banking, our Chief Economist, and four external members appointed directly by the Chancellor. The MPC meets for three and a half days, eight times a year, to decide the official interest rate in the United Kingdom (the Bank of England Base Rate).

Therefore, it has a significant impact on the movement of the Pound.

Economic data

The crucial economic data of the UK include GDP, unemployment, industrial production index, average income, UK Consumer Price Index (CPI), Manufacturing Purchasing Managers Index (PMI), money supply, etc.

UK Bonds

UK 10-year bond yields also have an impact on the movement of the Pound.

The FTSE 100 index

The FTSE 100 is the leading equity index in the United Kingdom. It is a market-capitalization-weighted index of UK-listed blue-chip companies. The index is part of the FTSE UK Series and is designed to measure the performance of the 100 largest companies traded on the London Stock Exchange that pass screening for size and liquidity. Compared to its peers in the United States and Japan, it affects local currency movements less, but it still has some influence, especially on market sentiment overall.

Correlation with the Euro

The Pound is geographically close to the Eurozone and has a deep political and economic relationship with the region. Therefore, it is one of the currencies positively correlated with the Euro.

The following chart shows the daily cycles of GBP/USD, GBP/JPY, EUR/USD, and EUR/JPY. The chart indicates several occurrences where the movements of these pairs exhibit a consistent pattern. This suggests the existence of trends or regularities that traders or analysts can identify and potentially leverage for decision-making in the foreign exchange market.

Correlation with the oil market

The United Kingdom, with its North Sea oil fields, is also vulnerable to oil prices. The chart below shows the oil price on the daily cycle chart of GBP/USD and GBP/JPY.

In the market, some factors only affect oil, while others exclusively affect the Pound. Although the movement may not be completely consistent, we can see that they often move in the same direction. The way oil prices impact GBP depends on whether the country is a net importer or exporter of oil and how the rising or falling prices of oil influence the trade deficits and surpluses of the UK.

Volatility increases significantly when the European market opens

Like the Euro, the British Pound has little volatility in the Asian market, and trading will increase significantly after the European market opens. When doing intraday trading, it is more efficient to trade after the European market opens.

There are two common ways to earn a GBP spread in the FX market by investing in GBP

1. Carry Trading
2. FX Trading

Carry Trading (overnight interest)

Carry trade refers to currency spread trading, which involves borrowing a low-interest-rate currency and converting it into a high-interest-rate currency to earn the interest difference between both.

The trading logic of carry trading is to borrow low-interest currencies and hedge against high-interest currencies. Therefore, in carry trade, the Japanese Yen is usually borrowed to hedge against high-interest currencies such as the Australian Dollar, New Zealand Dollar, and South African Rand. The market also sometimes uses GBPJPY as a carry-trade currency pair. There is little margin to earn in the case of the GBP/USD currency pairs, so this method is not recommended for GBP/USD trading. However, carry trading requires a comprehensive risk management strategy, as exchange rate swings can amplify potential gains or losses.

FX Trading

FX trading is easy to understand. It involves trading the price difference between two currencies and profiting from it.

For example, when the exchange rate between the British Pound and the US Dollar is 1:1.30, $1,300 is exchanged for £1,000.

If the Pound appreciates and the exchange rate between the Pound and the US dollar rises to 1:1.40, you exchange 1,000 pounds for US Dollars and ultimately get $1,400 back, making a $100 profit.

There will be losses if the Pound depreciates (or the Dollar appreciates).

Channels for investing in GBP in the FX market:

1. Spot Trading: The full notional amount is required for the trade. It involves immediate exchange of currencies at the current market rate.
2. Futures Trading: Here, margin trading is allowed, typically around 2% on platforms like CME (Chicago Mercantile Exchange). Contracts specify future exchange rates for a predetermined date.
3. Contracts for Difference (CFD): This allows trading on margin. Investors can benefit from price movements without owning the underlying asset.

All three channels entail exchange rate risk, where the value of the Pound Sterling against the US Dollar (GBPUSD) can fluctuate, influencing the profitability of the investment.

Spot trading

Investors in the FX market do not use spot trading to trade the GBP/USD because this trading model lacks efficiency; even if there is a profit margin, it will be affected by the exchange difference. Spot trading demands a full upfront capital commitment, significantly tying up funds compared to margin-enabled methods. This characteristic, coupled with exposure to immediate exchange rate risk, where adverse movements in GBP/USD can impact profits, contributes to the possible inefficiency of spot trading. Additionally, the limited leverage offered in spot trading, in contrast to futures and CFDs, might pose a drawback for traders seeking higher leverage. Concerns about potentially less favorable transaction costs, such as bid-ask spreads, further contribute to the considerations when choosing between trading methods.

Therefore, spot trading is sometimes considered the worst trading method in the FX market.

Futures trading

A foreign exchange future of GBP/USD is a forward contract transaction with a leverage and margin system, so investors can operate the GBP/USD if they have enough margin. Still, usually, the margin threshold is relatively high, so this may not be appropriate for traders with a low volume of funds.

Contracts for Difference (Forex margin)

The most efficient way to invest in GBP is to use Contracts for difference (CFDs), because they allow investors to participate in the market with a small amount of funds. Through leverage, investors can invest in the market by paying a small proportion of the margin. When the expected asset rises, they can hold long CFD positions. The ability to profit from both rising and falling markets through short selling adds versatility not always found in spot and futures markets. Additionally, margin trading in CFDs provides capital efficiency, making them an attractive option for certain investors. However, traders should be mindful of the associated risks, particularly the potential for substantial losses due to leverage. When the expected asset falls, they can hold short positions. Therefore, CFDs are a good option for trading long and short positions.

When trading CFDs, the most important thing is to choose the right CFD broker.

1. The broker should be a reputable dealer to reduce possible disputes.
2. They should be supervised by major global regulators to protect investors.
3. They should offer fund protection, convenient access to funds, and guaranteed withdrawal services.

OANDA is the world's leading Forex and CFD broker, offering CFD trading on GBP pairs. It enjoys a history of more than 25 years and a total of six regulatory licenses worldwide:

1. The UK Financial Conduct Authority (FCA)
2. The US Commodity Futures Trading Commission (CFTC)
3. Canadian Investment Industry Regulatory Organization (CIRO)
4. Australian Securities and Investments Commission (ASIC)
5. Japan Financial Services Agency (FSA)
6. Monetary Authority of Singapore (MAS)

Among the six licenses held by OANDA, the FCA of the United Kingdom, the CFTC of the United States, and the FSA of Japan are the most difficult to obtain because all of them are well-known globally as strict financial regulatory agencies and are the "top licenses" for traders.

In addition, there are several advantages to choosing OANDA to trade GBP.

Advantage 1: OANDA offers two Forex trading platforms

OANDA offers both MT4 and MT5 trading platforms to trade GBP pairs. In addition to the desktop version, it is available on iOS, Android, and web platforms. You can also trade the FTSE 100 index, the Euro Stoxx 50 index, and other commodities on the platform.

Advantage 2: There are many GBP pairs

In addition to the primary pairs, such as GBP/USD and EUR/GBP, other pairs, such as GBP/NZD, are also available. See the list below for details.