The US dollar (USD) is the world’s biggest reserve currency. It’s dominance has massive implications for almost all investors, including those in the UK. Yet, what is the relationship between the USD and the British pound (GBP)?
What might happen this year between the two currencies, and how might UK portfolios be impacted, especially those with holdings in startups and private equity?
Below, our investment team at Bure Valley Group explore these questions and offers ideas for investors as they consider their strategies for 2025.
Why does USD matter?
The relationship between USD and GBP is very significant. Last year alone, the UK imported £57.4 billion of services from the US (19.5% of all service imports). It also exported £126.3 billion (over 25% of total service exports).
The price relationship between these currencies has a huge impact on the balance of trade. If GBP rises against USD, for instance, then US imports become cheaper and UK exports get more expensive for American consumers. The inverse is also true.
This price movement can, in turn, affect consumer behaviour. If US goods become cheaper than British-sourced goods, UK consumers might switch to the former when buying. This can have knock-on effects for the wider economy – e.g. leading to a contraction in a domestic sector and potentially causing a worrying imbalance in the UK’s industrial base.
Foreign exchange (forex) can also affect foreign direct investment (FDI), which can be a vital source of jobs and funding for companies. If a currency weakens, foreign investors may start to sell it for more desirable ones on the international market. The result is an increase in supply, possibly worsening the exchange rate further and causing further “hot money outflows”.
What is going on right now?
As we write this in early February, the pound (GBP) has been on a bumpy ride with USD. Since September 2024, GBP has weakened from $1.34 for £1 down to $1.22 at a low-point in January.
A huge reason behind this market anticipation of “Trump Tariffs” arriving on imports from major trading partners to the US (e.g. China, Canada and Mexico). The likely effect of tariffs would be rising prices for consumers in the US.
Higher inflation will put pressure on the Federal Reserve (the Fed) to maintain or raise interest rates in 2025. This will potentially enable currency investors to gain better returns from holding USD relative to other currencies – especially if the latter experience falling interest rates in their home countries this year.
At the time of writing, the Bank of England (BoE) has just cut the UK base rate to 4.5%. GBP quickly fell to $1.237 in response to the news. Markets are widely expecting three further cuts later in the year, especially since two members of the Monetary Policy Committee vote for an even steeper reduction in the February meeting.
Taken together, the trend seems to be pointing towards a year when USD could perform quite strongly relative to GBP. Of course, we cannot speak in certainties – only in headwinds and tailwinds which could influence how currencies broadly move in the months ahead. Events can (and often do) derail the best economic forecasts and models!
Planning investments for 2025
The current instability in currency markets is a reminder for investors to follow best practices and time-honoured principles as they build their portfolios in 2025.
It is always worthwhile to stress the importance of diversification – not only across assets (e.g. equities and bonds) and within them (e.g. across verticals), but also across currencies. By engaging in prudent currency hedging, an investor can help protect the value of international holdings. Examples include currency futures, currency-hedged ETFs and currency options.
For early-stage investors, consider the deeper mechanics of your company investments and how currency movements could affect their performance in 2025. For example, a startup may have a highly global supply chain involving multiple currency exchanges. If you are concerned about volatility, have the founders demonstrated robust plans to handle large forex movements (e.g. by using forward contracts to “lock in” exchange rates for future transactions)?
In all of this, be wary of the potential limits and risks of currency hedging. For instance, if you hedge against a currency due to an expectation of weakening, your gains could be limited if the opposite transpires. Remember, currencies tend to balance over the longer term. A greater investment horizon may lessen the need for hedging (which can also be expensive).
Invitation
Currency movements have an important but often “hidden” effect on an investor’s returns and the inner workings of their underlying investments.
It helps to check your long-term strategy on a periodic basis (e.g. yearly or bi-yearly) to make sure your assets still align with your goals and needs – as well as wider macroeconomic conditions. A financial adviser could help many investors gain greater clarity in this key area.
Want to speak to us about our early-stage opportunities here at our exclusive investor network? Get in touch today to explore our startup projects here at Bure Valley Group.
