Rules of the Road

The strongest factors influencing the direction and momentum of the FX rate are major macroeconomic indicators, chief among them the changes in the Bank of England’s (BoE) key interest rates. Higher interest rates make the currency more attractive and lead to a stronger Pound. Interest rate policy is determined by the Monetary Policy Committee (MPC), which meets several times a year and whose decisions are closely watched by all FX traders.

Seasonal factors play an important, but secondary role in determining the FX rate. FX market trading activity is heavily influenced by the concept of volatility. In finance, volatility is a measure of variation in a trading price of a financial instrument (such as an FX rate), measured over time. Volatility is a function of supply and demand, meaning that volatility is high in periods of increased trading activity, and low when trading volumes are decreased.

While volatility is often associated with risk, it is simply a measure of how actively buyers and sellers are making trades. In this manner, measuring volatility can be used as a rough proxy for “trading activity” in general. Seasonal periods with higher volatility tend to have more trading activity, and vice versa.

There is an observable increase in market volatility in the first two quarters of the year, but this is not always directly correlated with a stronger GBP in the same time period. Seasonal behaviour patterns exist in FX markets, but they do not necessarily always affect the direction in which the FX markets move. Seasonal patterns have a much stronger effect on the volume of trading, rather than on the FX rate itself. Beginning of the year is often marked by an increase in trading activity which typically begins to subside as the markets approach summer months, with August being a low point of the year in terms of trading volumes.

Charting the Future

Ultimately, when making a decision to buy or sell foreign currency in anticipation of a large-scale foreign investment, businesses and households need to take into account crucial macroeconomic factors that influence FX markets.

The key events for the upcoming Q2-Q3 2018 that will need to be taken into consideration by people trading Pound Sterling (both EUR/GBP and GBP/USD pairs) include the all-important MPC meetings on the following dates:

• May 10, 2018. Consensus likelihood of rate change: 6% (down from 85.9% a week before)
• June 21, 2018. Consensus likelihood of rate change: 7% (down from 85.8% a week before)
• August 2, 2018. Consensus likelihood of rate change: 6% (down from 70% a week before)
• September 13, 2018. Consensus likelihood of rate change: 2% (down from 69% a week before)

 (Source: Bloomberg, 26.04.2018, World Interest Rate Probability)

FX traders need to pay especially close attention to the May 10^th and August 2^nd MPC meetings, when the BoE will be releasing its Inflation Report Publications, reports that set out inflation projections and heavily influence Bank policy on key interest rates.

Earlier this season, analyst consensus on Bloomberg had a high level of confidence that key interest rates will be increased this year, leading to a stronger Pound Sterling. If rates stay unchanged through the year, the Pound could come under downward pressure, so paying close attention to BoE announcements is critical for FX traders.

Other important news that FX traders interested in either GBP pair also need to consider is the outcome of Brexit negotiations. Any news of successful resolution of outstanding issues regarding the Irish border and the rights of EU citizens living in UK is sure to be taken positively by the market and has the potential to further strengthen the Pound.

Finally, release of other key data, especially related to UK economic growth, unemployment and incomes, can also have a major effect on Pound Sterling in the coming months. Further news of stagnant wage growth can put GBP into negative territory, so market participants need to be aware of future announcements and be prepared to safeguard their FX investments.

GBP/USD

(Source: CMC Markets, 26.04.2018, 1 Year, Daily Chart)

In the short-to-medium term, GBP/USD could remain under the twin pressures of low interest rates and lower than expected inflation, rangebound between levels of 1.37 and 1.43, with longer term technical indicators pointing toward a stronger Pound. This longer-term support level at 1.39 has been heavily tested in the recent days and it remains to be seen whether there is potential for a bullish reversal toward 1.43.

EUR/GBP

(Source: CMC Markets, 27.04.2018, 1 Year, Daily Chart)

Much like its transatlantic “cousin”, EUR/GBP is currently trading in a range, but with a more pronounced negative momentum going into Q3 2018. This FX pair has been testing support levels of 0.865, with a potential to break through to 0.879. There is upside all the way to 0.895, however, reaching it in Q2 2018 is predicated on significant changes in the macroeconomic environment.

FX Markets are a constantly evolving ecosystem that is influenced by a large array of complex factors. The next section will outline the structure of FX markets and their main driving forces.