A Traders Introduction to the British Pound

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In our last lesson we finished up our discussion of the Japanese Yen with a look at some of the major factors which move the currency, as well as where traders can go to find out more information on those indicators. In today’s lesson we are going to discuss the 4th most actively traded currency in the world, the British Pound.

Although the United Kingdom is a member of the European Union, it has not yet adopted the Euro as its currency, so it is not part of the European Monetary Union. There are a number of reasons for this, but perhaps most famous is the country’s forced withdrawal from the Exchange Rate Mechanism, the precursor to the Euro. As we have touched on in previous lessons, before joining the Euro countries were required to meet certain criteria, one of which was to keep the value of their currency within certain bands. After initially trying to adhere to the qualifications set forth for participation in the European Monetary Union, the value of the pound dropped below the lower band, forcing the country out of what would become the European Monetary Union. Although the Prime Minister as of this lesson, Gordon Brown, has ruled out joining the European Monetary Union for the foreseeable future, many feel that the UK will eventually adopt the Euro, and therefore any such talk can have an affect on the pound.

The former Prime Minister of the United Kingdom laid out 5 broad economic tests that must be passed, before the UK would consider adopting the Euro. These would of course be in addition to the requirements set forth in the Maastricht treaty, which we learned about in our lesson on the Euro.

The five tests according to Wikipedia.org are:

1. Are business cycles and economic structures compatible so that the UK and others could live comfortable with Euro interst rates on a permanent basis?

2. If problems emerge is there sufficient flexibility to deal with them?

3. Would joining the EMU create better conditions for firms making long-term decisions to invest in britain.

4. What impact would entry into the EMU have on the competitive position of the UK’s financial services industry, particularly the city’s wholesale markets?

5. In summary, will joining the EU promote higher growth, stability, and a lasting increase in jobs?

In addition to these factors, the UK economy is a service based economy, with a heavy emphasis on financial services, and is a net exporter of oil and natrual gas, so energy prices will affect the currency.

As Kathy Lien points out in her book Day Trading the Currency Market, while the GBP/USD is a very active currency, the Pound is also very active in the crosses, and as the EU is their largest trading partner, traders pay particular attention to movements in the EUR/GBP for fundamental ques on the currency. As of this lesson the UK also has the highest interest rates in the G7, causing it to be used as the currency many traders will buy when playing the carry trade we learned about in module 3 of this course. This makes GBP/JPY one of the more active crosses in the market and one which traders who are looking for increased volatility often choose as their favorite.

Like the other currencies which we have studied, fxwords.com offers a great page listing all the indicators which move the currency, their definition, and relative importance to the market which you can find a link to below this video. This, along with the global calendar which you can find at the top of Dailyfx.com, provides a great overview and release times for all the major indicators which move the market.

Thats our lesson for today. In our next lesson we are going to look at the world’s safe haven currency the Swiss Franc so we hope to see you in that lesson. As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!