BAFI1002 Financial Markets: Short-Term Prospects of USD vs GBP

This report analyzes the future prospects of the USD against the GBP in the foreign exchange market. It considers macroeconomic factors such as relative interest rates, inflation rates, and growth rates in both the US and the UK. Technical analysis, political scenarios like Brexit, and market expectations are also evaluated to determine short-term currency movements. The report concludes with a speculative outlook, suggesting a long position on USD and a short position on GBP, while also recommending hedging strategies to mitigate market uncertainties. Desklib offers a variety of similar reports and solved assignments for students.

FOREIGN EXCHANGE MARKET
A. Purpose of report
The report has been prepared with the intention to explore future prospect of USD or American Dollar
to GBP or Sterling Pound. The report contains an in depth analysis of the future prospects in the short
term based on various macroeconomic factors of both jurisdictions involved.
B. Currency Chosen
GBP and USD
1 GBP=1.29 USD (03 September, 04:42 PM)
C. Introduction
Foreign Exchange Market is one of the largest financial markets in the world. The US and UK market
shall account for majority of the transactions. The majority of transactions occur at London, New
York and Tokyo. Foreign market participant generally enter the market with an intention to hedge or
speculate or make an arbitrage gain.
The following macroeconomic factors have been analysed to determine the prospect of currency in
near future:
(a) Relative Interest rate: A higher rate of interest rate prevailing in a country generally results in a
higher value of a currency compared to country with a lower rate of interest. It is one of the major
factors that influence the exchange rate of one currency in terms of another.
The above phenomenon occurs on account of attraction of foreign investment as higher interest
rates attract investors resulting in demand for the currency and corresponding increase in the price
of currency. Currently, the rate of interest prevailing in USA as proposed by FED is 2%
(TRADING ECONOMICS, 2018)while the rate of interest prevailing in UK is 0.5 % as proposed
by Bank of London (Bank of England keeps interest rate at 0.5%, 2018). Thus, on the basis of the
same, US dollar shall rise compared to GBP. However, there are multiple other factors that need
to be harped on for deciding future prospects.
(b) Relative Inflation rates: The term inflation generally means increase in prices of goods and
services in a country over a defined period. It has a general impact on foreign exchange rate of a
country in terms of another. A higher inflation rate in the economy is a symbol of falling foreign
exchange in the future as proposed by chief economist David Ricardo under his theory of Law of
one price in 19th century.
The above phenomenon generally occurs on account of lowering of basket of good purchased
with 1 unit of currency on account of increasing inflation in the economy. While for the cross
currency the basket of goods shall be higher resulting in rise of currency rate for a country with a
lower inflation rate. Under, the present scenario, the inflation rate in America is 2.9 percent as on

July, 2018 (highest since February, 2012) while the rate of inflation prevailing in UK is 2.6%
(Consumer Price Index is 2.4% in May)1. Thus, in terms of the aforesaid theory, the prices of
GBP shall rise in terms of US Dollar.
(c) Relative Growth Rates:The Growth rate of economy i.e. GDP is an important indicator of foreign
exchange rates. The higher the rate of growth of the economy the stronger will be the currency
compared to other. Thus, a stronger GDP is an indicator of a healthy economy and a strong
currency.
The above phenomenon generally occurs on account of increasing competitiveness, increased
production of goods and services and strong economic performance. Currently, the rate of growth
of US Economy is 4.2 % as on July, 20182 while the rate of growth prevailing in UK is 0.4%.
Thus, UK economy has been growing at a much slower pace compared to US economy.
(d) Technical Factors: On the basis of technical analysis and tools in the form of graph, charts and
other associated tools, it can be derived that value of USD shall rise compared to GBP on account
of strong up support and favourable economy. The analysis has been presented here-in-below:
1https://www.google.co.in/search?
ei=8WONW4bMLoyoyAPTrZ7ABw&q=Uk+inlfation+rate&oq=Uk+inlfation+rate&gs_l=psy-
ab.3..0i10k1l10.65872.70160.0.70411.17.14.0.0.0.0.361.1315.0j4j1j1.6.0....0...1.1.64.psy-
ab..11.6.1311...0j0i131k1j0i67k1.0.IzktZoqvbeQ
2https://tradingeconomics.com/united-states/gdp-growth

On the basis of above, it may be understood that prices of dollar against GBP shall stand at 0.75 by 2023
and it shall strengthen by 2,25% in a year. (Walletinvestor.com, 2018)
Political Scenario: The political scenario currently prevailing in UK is a disturbed with major issue
being Brexit (Britain Exit from European Union) causing a weak sentiment towards the GBP
currency in the global scenario. Investors are losing confidence under the present scenario resulting
in weakening of currency in the nearby future. The same shall result in a staggering loss to the
currency. Further, many business houses are pulling out of the economy entirely resulting in lower
GDP and falling demand for the currency.
In the USA Market, similar tension and problem persists with Mr. Trump, the honourable
President of USA taking stern decisions to overturn the world economic order. The major
decisions recently undertaken including firing of major members of his cabinet, withdrawing for
Paris climate convention, backing out of Iran deals, trade wars etc.
Thus, the aforesaid measures have a negative impact on both currencies. However, the impact of
Brexit is haunting the UK economy and is a major cause of concern for European Union.
(e) Market Expectations: The market sentiments playa very crucial role in determining the short term
prospect of a currency compared to other. In the near future, the fear of Brexit being heightening
and soft manufacturing in Britain a negative market sentiment seems to overshadow the Pound
sterling with a near term fall against the US Dollar.
The matter shall be further worsened with recovering American economy from slowdown and
rising FED rates attracting global investments.
Thus, on the basis of the above analysis it may be worthwhile to come to a conclusion that GBP
shall fall compare to American Dollar in the near future on account of aforesaid factors. Thus, as a
speculator in the near term, I shall propose to go long on USD and short on GBP making margins
out of speculations. Further, for a hedge I shall propose to mitigate the exposure on account
greater uncertainty prevailing in the global market and strong economic decisions undertaken by
leaders of both the jurisdiction creating impact on respective currencies.

Bibliography
Bank of England keeps interest rate at 0.5%. (2018, May 10). Retrieved September 4, 2018, from
www.independent.co.uk: https://www.independent.co.uk/news/business/news/uk-interest-rates-latest-
update-bank-england-pound-sterling-price-latest-mark-carney-a8344691.html
TRADING ECONOMICS. (2018). United States Fed Funds Rate. Retrieved September 4, 2018, from
tradingeconomics.com: https://tradingeconomics.com/united-states/interest-rate
Walletinvestor.com. (2018). Is "United States Dollar / British Pound Sterling" Pair a Good Investment? .
Retrieved September 4, 2018, from walletinvestor.com: https://walletinvestor.com/forex-forecast/usd-gbp-
prediction