Great Britain Pound commonly referred to as the pound, but some people still refer to it as sterling. But regardless of what it may be called, the British pound sterling remains to be one of the strongest currencies throughout the world. It comes as a surprise to some especially those outside of Britain and those who don’t travel quite often but it actually makes a lot of sense for the pound to be so expensive and stronger than US Dollar.

Is the pound stronger than the dollar?

That’s always the question in the minds of new traders. The United States of America has the most robust economy but not the strongest currency in the world. According to an analysis of the Top Ten Strongest World Currencies, the US dollar (USD) ranks at No.9 and the British Pound (GBP) at No. 5. There are various reasons why the pound is being strong which is explained here.

What Determines the Currency Strength?

A country’s economic strength and the nominal value of a country’s currency are vital determinants, though not always the main drivers in its currency valuation. The relative value versus the nominal value is considered in determining the strength of the currency. How the value of currency changes over time relative to other currencies is more critical than its exchange rate. When money continually increases in value in comparison to another, it is considered a stronger currency. The best way to judge a currency’s strength is by observing its value in relation to other currencies over many years. Inflation, supply, demand, and other economic factors change a currency’s relative price, ultimately determining its strength.

Nominal Value vs. Relative Value

The nominal value of a currency is relatively arbitrary. What matters is how the value of that currency changes over time relative to other currencies. Historically, for over 20 years one U.S. dollar has been worth less than one British pound. As of July 31, 2020, the dollar is sitting around 1.32 to one pound. This is down from 1.68 in May 2014 and 1.40 in March 2018. This trend is indicative of deteriorating economic conditions in the United Kingdom, mainly from Brexit, combined with an improving U.S. economy.

It’s also worth considering that many more dollars are in circulation than pounds. As of July 2020, nearly 1.93 trillion U.S. dollars were in circulation. By contrast, the total pounds in circulation came to a mere 70.16 billion. To draw an analogy, the 2020 market capitalization of Berkshire Hathaway Inc. (BRK.A, BRK.B) was much lower than that of Microsoft Corp. (MSFT) despite the fact that Berkshire Hathaway’s share price is much higher. This is because there are many more outstanding Microsoft shares than Berkshire Hathaway shares.

Consequences of Brexit

On June 23, 2016, British citizens went to the polls and voted in favor of a referendum to leave the European Union (EU), of which the country had been a member since 1973.  The “Brexit,” or British exit, came about as a result of a populist movement that had grown weary of ceding control of laws and regulations to outside forces in Brussels and feared the effects of what it viewed as unchecked immigration. Economists, most of whom were confident that Britain would vote to remain in the EU, warned of economic consequences that would result from Brexit.

The vote in favor of Brexit shocked oddsmakers and roiled world markets. It also had an immediate and pronounced effect on the British pound, which declined in value by over 8% in the 24 hours following the vote. This is another example of relative value trumping nominal value. While the pound remained stronger than the dollar in nominal terms, investors still abandoned the currency, citing its precipitous decline in relative value.

Looking at the last five decades, it is evident that at least one ‘major event’ each decade affects the volatility of the GBP to USD rate. These significant events vary from natural disasters, financial or political crises, wars, and, most recently, COVID. In the 1990’s it was the Gulf War, in the early 2000s it was the Global Financial Crisis, in the early 2010s it was the Brexit referendum. The pound has been turbulent and volatile since the 2016 Brexit announcement. Near the end of 2016 the GBP/USD reached lows around 1.20. In 2018 there was a slight rebound, peaking at around 1.40 in April 2018.

And now, in the 2020s it is the Coronavirus pandemic, in March 2020, the currency pair reported some new lows around 1.16. The ongoing coronavirus pandemic has caused massive uncertainty of structural changes, and more needs to be done to tackle the increase of unemployment. The scarring of the outbreak was evident in the exchange rates of the two currencies. In March 2020, when the first wave of the Coronavirus occurred, pounds to dollars exchange rate took a 12% dive. The US Dollar was perceived to be safer at the time, causing investors to sell the GBP in its favor. This month it saw the USD hit its lowest in the last two years though it immediately did a rebound, erasing some of its recent losses. The non-farm payroll figures were not as expected, and traders saw the EUR/USD pair take a deep dive before it started regaining its position. The GBPUSD pair also strengthened.