GBP/USD is rising but still exposed to the downside

The pound sterling (GBP) is the oldest currency in the world (886 AD) and the official currency of the United Kingdom. It is the fourth most traded foreign exchange (FX) unit in the world, accounting for 12% of all trades, averaging $630 billion per day as of 2022. Its key trading pairs are GBP/USD, aka “Cable”, which represents 11% of FX, GBP/JPY or “The Dragon” as it is known to traders (3%) and EUR/GBP (2%) . The pound sterling is issued by the Bank of England (BoE).

The most important factor influencing the value of the pound sterling is the monetary policy decided by the Bank of England. The BoE bases its decisions on whether it has achieved its main objective of “price stability” – a steady inflation rate of around 2%. Its main tool to achieve this is the adjustment of interest rates. When inflation is too high, the BoE will try to control it by raising interest rates, making it more expensive for people and businesses to access credit. This is generally positive for GBP as higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls too low, it is a sign that economic growth is slowing. In this scenario, the BoE will consider lowering interest rates to reduce credit so that companies borrow more to invest in growth-generating projects.

Data releases measure the health of the economy and can affect the value of the pound. Indicators such as GDP, manufacturing and services PMI and employment can all influence the direction of the GBP. A strong economy is good for Sterling. Not only does it attract more foreign investment, it may encourage the BoE to raise interest rates, which will directly strengthen the GBP. Otherwise, if the economic data is weak, the pound is likely to fall.

Another significant release of data for the pound is the trade balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports in a given period. If a country produces highly sought-after exports, its currency will only benefit from the additional demand created by foreign buyers looking to purchase these goods. Therefore, a positive net trade balance strengthens a currency and vice versa for a negative balance.