Sterling may have hit a low against the US dollar in January 2009, but the following months have seen it gaining strength. So, what are the factors that have kept the pound strong? And what might affect its progress in the months to come?
2009 has been a dramatic year for cable – the GBP/USD exchange rate – with sterling climbing steadily from its January low of 1.386 to reach 1.6722 in December against the US dollar. The US dollar itself has declined against a number of major world currencies, including the Australian dollar.
A number of factors have brought about sterling’s performance against the US dollar this year. Low interest rates in the UK helped lift house prices there in 2009, while at the same time UK government initiatives have spurred a revival in lending sterling. Another, less obvious reason for sterling’s strength, relative to the US dollar, is the tax amnesty on offshore accounts for UK residents, which further contributed to house price inflation as many opted to put their money in UK real estate as an alternative to declaring their holdings in offshore accounts.
On the macroeconomic front, sterling has been boosted by UK retail sales, which also rose in 2009 as retailers slashed prices to encourage expenditure and European consumers took advantage of the strong euro to pick up bargains. The final months of the year have also seen a significant surge in consumer confidence in the UK, which bodes well for Christmas sales.
The other side of the coin
But what about the US dollar? Crucially, the US currency depreciated on the view that US interest rates will remain low for a prolonged period of time. This has transformed the US dollar into a funding currency, whereby traders can borrow cheaply in dollars and invest those funds into foreign higher yielding securities, making a profit on the differential.
This phenomenon, along with an improvement in UK and general global economic conditions, has encouraged investors to take on more risk. Further deprecation of the US dollar has led to appreciation of commodity prices, enhancing the value of resource shares.
The US dollar is perceived as a safe haven instrument. Investors increase their exposure to treasuries in times of doubt as they are considered to be ‘risk free’. So, in a nutshell, what has happened this year is that greater risk appetite has resulted in the depreciation of the US dollar which in turn led to appreciation in higher risk currencies, such as sterling, the Australian dollar and the euro.
Looking ahead
So, what next? At this point, the outlook for sterling is dependent on two key factors. First and foremost is quantitative easing (QE). If the Bank of England curbs its QE policy, this will have a positive effect on the pound, while a decision to expand would have a negative effect.
The second key factor is stock market correction. If the FTSE continues to rally, then the knock-on effect for sterling will be positive.
Investors will also be keeping a close eye on wider developments that may affect the FTSE including interest rate expectations, seasonal retail sales, commodity prices and how the BoE manages the withdrawal of its economic stimuli. Any tightening of the UK government’s fiscal policy – a raise in taxes for example – or an announcement of cuts in government spending could also weigh heavily on sterling. The weakened UK commercial real estate sector and potential bad news from Dubai may also have a part to play in the currency’s fortunes for 2010.
Trade on cable
If you have an opinion on the current or future prospects of sterling, or any other global currency, forex trading offers a flexible and simple way to profit from movements in currency markets.
To help you keep an eye on the various factors that could affect the future of this pair, we provide a guide to key global Economic Indicators which explains their significance as well as providing details of analyst expectations and when the figures will be released. We also have available, Forex Focus, which provides daily updates on three of the major currency pairs. This includes performance charts with accompanying analyses.