When comparing currencies in the foreign exchange market, the British pound (GBP) and the US dollar (USD) stand among the strongest. Both currencies are backed by two of the world’s strongest economies and are popular in FX trading. Although the USD is more popular than the GBP, the latter is stronger than the USD in value and maintains a strong position in the GBP/USD trading pair. Here, you’ll learn why this happens, the factors impacting the values of currencies, and how forex traders take advantage of it to make profits.
The GBP
The GBP sits fifth on the list of the most valuable currencies in the world. It is also the strongest currency with the biggest popularity in the forex market. The GBP is the fourth most-traded currency, having about 12% of the global currency trading volume. The GBP is backed by one of the strongest economies and maintains a strong position against the USD. As one of the world’s reserve currencies, the GBP is the oldest currency still in use today. While the GBP/USD pair is popular in forex trading, the GBP enjoys a strong position against many other currencies in the market.
The USD
The USD, surprisingly, sits tenth on the list of the world’s strongest currencies. Despite being the most popular currency in the forex market and the biggest world’s reserve currency, the USD is weaker than several less popular currencies. The USD is backed by a strong economy and is one of the most widely adopted currencies; 66 countries currently peg their currencies to the USD. Over 88% of global forex transactions are made in USD, making it the most significant currency in the market. Although the US is one of the wealthiest countries, the USD has failed to gain a stronger position than the GBP.
Why is the GBP Strong?
While it seems odd that the GBP holds a stronger position against the USD, the US is more affluent than the UK based on the GDP per capita. So why is the GBP so strong against the USD? Here are the top reasons:
Trade Surplus and Deficits
The UK has a high trading surplus and low trading deficit, with over 44% of its exports going to the Eurozone, while just about 16% of the Eurozone exports go to the UK. A robust internal economy and production policies ensure that the UK maintains a strong position against the USD due to its trading surplus. As the UK also demands payment in its local currency, the GBP retains its strength without falling so much against the USD or the euro.
Budget Surplus and Deficits
The budget deficit measures the government’s loans to fund the budget. As of Q1 2022, the UK budget deficit stands at £15.8 billion, while the US budget deficit, revised by the White House, stands at $1.032 trillion. The combination of trading surplus and deficit and budget surplus and deficits over time will determine the strength of a currency. The UK has maintained an overall higher trading surplus and lower budget deficit than the US over the years, contributing massively to the strength of the GBP against the USD.
Economic Growth
The pace of the UK’s economic growth is also an essential factor in the price of the GBP. Pre-Brexit UK had one of the fastest-growing economies, outperforming many EU countries and even the US. Since the mid-80s, the UK has had a more robust and faster economy, making its GBP more valuable in international trading. Although Brexit made the UK economy struggle and become the least-performing economy in the Eurozone, the effects gradually waned after the UK signed the 2020 Exit Plan. The economy is slowly recovering despite inflation and higher energy costs.
Monetary Policies
The UK has one of the strongest monetary policies in the world, with increasing interest rates. The interest rate was raised to 1.75% in August 2022, up 0.5 percentage points. An increase in interest rate always improves the demand for the currency as investors seek higher returns. Other policies, such as quantitative easing (QE), help stabilise and ensure lower rates when necessary.
Oil Exports
Until 2005, the UK was a net oil exporter, shipping most of its oil to the Eurozone and China. But since 2006, the UK has imported oil products in smaller quantities than the EU countries. Decades of oil exportation placed the GBP as one of the stronger countries in the world. The US, up until 2020, was a net oil importer, despite being an oil-exporting country. Although the UK reduced its oil exports, the oil revenue increased in 2022.
How Does GBP/USD Value Affect Forex Trading?
Because the GBP/USD, one of the most popular forex trading pairs, is the third most widely traded pair in the forex market and accounts for the majority of the USD flow in the forex market (about $330 billion) and about 11% of the forex market. Therefore, the value of the GBP/USD pair is significant in the forex market as it impacts trading. The GBP/USD pair also positively correlates with the EUR/USD pair; traders analyse the former to confirm their analysis of the latter. The GBP/USD is an essential asset in any trader’s portfolio. As two of the world’s popular currencies, a significant change in the price of either the GBP or USD will cause a ripple effect on other currencies.
Trading the GBP/USD Pair
Traders have access to trade the GBP/USD pair on regulated brokers. The key is to find a broker with the best FX trading conditions and trade the GBP/USD pair. Proper analysis is necessary to find the best entry and exit positions to maximise profits.
