Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

The sterling value trade

GBP/USD is surging, betting on the likelihood of a Johnson Brexit deal that has revalued a UK currency hammered by political risks. But GBP may already be repriced to fair value.

Sterling has been by far the best performing of the major currencies in recent months, up over 6% since September on a bet that Brexit uncertainties that have bedeviled virtually every aspect of British public and economic life are about to be settled.

Traders and investors were salivating at the prospects of a big revaluation of sterling, which had moved into severely undervalued territory in recent years as markets taxed the currency with a big political risk discount. It may be, however, that sterling has already been repriced to fair value. This despite the fact that, as former Prime Minister Tony Blair pointed out last week, even if Boris Johnson's Conservatives win a solid majority Brexit will again have to be renegotiated with the EU.

Purchasing power parity

The way currency analysts come up with an economic valuation, as opposed to a market valuation, for currencies is through a calculation called purchasing power parity (PPP), which adjusts for relative local purchasing power on a vast basket of goods and services to come up with a level an exchange rate “should” be trading at based on economic fundamentals.

In practice PPP is a moving target that market exchange rates rarely actually trade at, constantly undershooting and overshooting. But PPP is used by investors and forex traders as a guide to help determine the degree to which there might be inefficiencies in market pricing from which profits could be derived.

What’s been going on with sterling is a perfect example of such an inefficiency, hammered as the currency has been ever since political risk became the overwhelming determinant of UK pound exchange rates since Brexit passage several years ago.

Undershooting

The degree to which sterling has been undershooting fair value is startling, far more against the US dollar than other major currencies. The greenback is considered to be rather severely overshooting on a PPP basis after rallying strongly over the last two years, and especially since 2010.

The recent rally in sterling may have already closed the PPP value gap for GBP/USD. The UK pound’s discount to PPP was about 18% in early September. Sterling fair value aganst the US dollar is now around $1.41 vs about $1.285 last in New York trade, which is a market discount to PPP of 12%, about the same as EUR/USD currently.

So, it appears on this basis that sterling’s ability to continue to outperform other major currencies against the US dollar may be limited on a fundamental economic basis. The pound's upside may perhaps be, however, quite substantial on a euphoria driven rally even if the Conservatives win big in December.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

Start trading forex today

Find opportunity on the world’s most-traded – and most-volatile – financial market.

  • Trade spreads from just 0.6 points on EUR/USD
  • Analyse with clear, fast charts
  • Speculate wherever you are with our intuitive mobile apps

See an FX opportunity?

Try a risk-free trade in your demo account, and see whether you’re onto something.

  • Log in to your demo
  • Take your position
  • See whether your hunch pays off

See an FX opportunity?

Don’t miss your chance – upgrade to a live account to take advantage.

  • Get spreads from just 0.6 points on popular pairs
  • Analyse and deal seamlessly on fast, intuitive charts
  • See and react to breaking news in-platform

See an FX opportunity?

Don’t miss your chance. Log in to take your position.

Live prices on most popular markets

  • Forex
  • Shares
  • Indices
liveprices.javascriptrequired
liveprices.javascriptrequired
liveprices.javascriptrequired

Prices above are subject to our website terms and agreements. Prices are indicative only. All shares prices are delayed by at least 15 mins.

Plan your trading week

Get the week’s market-moving news sent directly to your inbox every Sunday. The Week Ahead gives you a full calendar of upcoming economic events, as well as commentary from our expert analysts on the key markets to watch.


For more info on how we might use your data, see our privacy notice and access policy and privacy webpage.

You might be interested in…

Find out what charges your trades could incur with our transparent fee structure.

Discover why so many clients choose us, and what makes us a world-leading provider of spread betting and CFDs.

Stay on top of upcoming market-moving events with our customisable economic calendar.