The British pound has been one of the strongest currencies before the 2008 global financial crisis. In fact, during the first half of that year GBP/USD traded well above 2.00 level. Many financial analysts, including Marc Chandler, warned investors that the British currency was extremely overvalued.
Sure enough, from late 2008 to early 2009, the Pound collapsed, falling to 1.43 mark against the dollar and nearly reaching parity with the Euro. It was a case of a sharp correction, however, it did not mark the beginning of any major downtrend. In fact, after this development, for more than 6 years, the price action of GBP/USD was confined between 1.40 to 1.70 range.
However, in terms of Pound’s exchange rates, the 2016 EU referendum was indeed a game-changer, this might well be the point where the true GBP long term downtrend began. As it became clear that the UK voted to leave the EU, the British currency lost at least 10% of its value against several major currencies. Such rapid decline led to many losses in the Forex market and the closing of trading positions.
However, thanks to the margin call system many traders were able to recover easily or at least save some of their capital during the first few weeks of the referendum where the major hits started to come through. If we take the time and see margin call definition here it’s clearly outlined that this tool is designed for events like this. An unpredictable change in the market that forces most active trades to bottom out was absolutely essential as not having any trades active during the speculative time of the referendum would have hit the currency much stronger than some losses here and there.
The rout continued for some weeks until GBP/USD settled for a new range between 1.20 to 1.40. By the beginning of 2020, it seemed like the Pound was starting to recover some of its losses, however, the emergence of the COVID-19 pandemic has struck another blow against the British currency. To confront the possible economic downturn the Bank of England reduced the key interest rate from 0.75% to 0.1%.
The results were predictable, According to BBC, during the middle of March 2020, the Pound fell to 30 year low, sinking to 1.15 mark against the dollar, and to 1.06 level against the Euro. Surprisingly the British currency somewhat recovered from those historic lows, with now GBP/USD trading near 1.23, however, if we look at any recent GBP charts there might be very little doubt that it is in a downtrend.
What Keeps GBP from Falling Even Further?
Obviously it is logical that leaving the EU without any trading agreement and near-zero rate policies of the Bank of England hurts the value of the Pound significantly. However, many market participants might still wonder: What keeps the GBP alive? Why has it not collapsed further? How it happened, that we are not talking about Pound going below parity with the Euro and the Dollar?
There are several possible explanations for those questions. Firstly, it is right that the Bank of England is keeping rates at historic lows, however the same goes for other major central banks. The yields of USD, AUD, CAD, NZD, EUR are between 0 to 0.25%. The Bank of Japan and Swiss National Bank even have gone as far as implementing negative interest rates, -0.1% and -0.75% respectively.
Consequently, despite the recent decisions of the Bank of England, the Pound still remains a slightly higher-yielding currency, then the Euro, the Japanese Yen, and the Swiss Franc. As for the other major currencies, the difference is just 0.15%, which is too small to make any significant difference.
Another factor at play here might be the Purchasing Power Parity implications. According to this theory, PPP is an exchange rate at which the average prices of goods of services are equalized in two different countries, and in the long term, currencies tend to gravitate around this level. According to several measurements, the Pound is already trading significantly lower compared to the Purchasing Power Parity levels.
For example, according to the data provided by the Organizations for Economic Cooperations and Development, the latest measure of the PPP of GBP/USD stands at 1.45, which is more than 15% higher than the current market exchange rates. In fact, according to the Economist, even back in January the Pound was 22% undervalued against the Dollar.
Finally, it might be helpful to point out that despite all of those setbacks, GBP still remains one of the world’s reserve currencies. According to the latest IMF report, the Pound still makes up 4.61% of the global currency reserves. This represents the 4th largest portion, after the US Dollar, the Euro, and the Japanese Yen.
In fact, the UK Pound was the world’s top reserve currency for several decades, before the American Currency has taken the lead after the end of WW2. Because of this, we can assume that GBP can still hold on to its reputation of stability.
In conclusion, there are several reasons, which helps the Pound to hold its ground, however, further depreciation can not be ruled out.