Factors impacting major currencies explained: Part 3, the British pound
Bank of England
The Bank of England (BoE) is operationally independent with respect to establishing monetary policy, with the aim of attaining price stability together with supporting the government goals regarding growth and employment. The objective of price stability is determined by the inflation target set by the government. The decision making process regarding the key interest rates is a responsibility of the Monetary Policy Committee.
Interest Rates
The main interest rate is the minimum lending rate used by the BoE; rate changes massively impact the sterling. Another area of monetary policy setting by the bank is that of daily market operations. The latter serve to change the dealing rates for BoE purchases of government bills from institutions (discount houses) specialized in trading in monetary market instruments.
Gilts
Gilts are government bonds. The difference in yields, termed spread differential, between the 10-year gilt and the 10-year US Treasury Note typically influences the GBP/USD exchange rate. Another spread differential of significance is that between gilts and German bonds: it has an effect on the EUR/GBP exchange rate, which in turn could impact the GBP/USD (as explained in “cross-rate effect”).
3-month Eurosterling Deposits
These are Eurodollar deposits or bank accounts in a country different from the one, where the currency originates; for example, sterling-denominated accounts outside the UK are dubbed “Eurosterling” ones. For 3-month sterling-denominated deposits lodged in banks outside of the UK, the interest rate is an important benchmark when determining interest rate differentials. The latter is one of the key determinants of exchange rates.
With interest rate differentials favoring Eurodollar against Eurosterling deposits, for instance, the likelihood of the GBP/USD falling is greater. In some cases that relation is not valid, owing to the interference of other factors.
Economic Data
Among economic data released in the UK, the most important figures for the British pound are: the unemployment rate and unemployment change; retail sales; average monthly earnings; consumer inflation; balance of payments; housing prices.
3-Month Eurosterling Futures Contract
That is a contract showing market expectations regarding 3-month Eurosterling. The difference between futures on 3-month Eurodollarand and 3-month Eurosterling deposits is a crucial variable in determining the GBP/USD exchange rate.
Cross Rate Effect
Cross exchange rates, like the EUR/GBP for example, sometimes do have an impact on the GBP/USD. A sharp rise in the euro exchange rate against the sterling, everything else being equal, would probably result in a drop in the GBP/USD, and vice versa.
