The Pound as a Pro-Cyclical Currency

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

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The British currency’s performance is partly influenced by global forces and Sterling tends to fall when global investor sentiment weakens. Particularly, this was evident when UK domestic economic data was limited, as Sterling was mainly driven by global trends. It is also characteristic that when the US dollar weakens, the pound tends to rise and vice versa, as the US dollar is a countercyclical currency and falls when global sentiment is positive. Instead, when global economy weakens, the dollar appreciates. 

The pound is seen then as a pro-cyclical currency, and the UK usually profits from investment inflows whenever global growth is strong. A currency that is procyclical is one that appreciates in good times and depreciates in bad times. Countercyclical are then the currencies that appreciate in bad times and depreciate in good times. It is argued that the countries that are commodity exporters and experience procyclical capital flows tend to have procyclical currencies. 

Procyclical Currencies

Cyclical or procyclical currencies such as the pound or the Australian dollar tend to rise when the global economy is expanding. In the case of Australia, global growth is beneficial to Australia's big raw materials export industry.

The Pound tends to appreciate against the dollar, yen and franc when global markets are growing. Commodity exporters from emerging markets such as Chile, Brazil and Russia also have procyclical currencies. Advanced commodity exporting countries, such as New Zealand and Australia also have procyclical currencies. Switzerland, Japan, the US, Germany and the Eurozone, have countercyclical currencies.

But What Determines Currency Cyclicality?

It has been argued that pro-cyclical currencies are usually affected by changes in the prices of commodities and are likely to receive “ procyclical capital inflows.” Such countries are said to find it difficult to follow countercyclical monetary policy as it could drastically impact their exchange rates.

It has also been stated that whether a country has a procyclical or countercyclical or even an acyclical currency, does not seem to affect its economic health and there is no evidence that a country would do better with a procyclical or countercyclical currency. 

In countries with procyclical currencies, the exchange rate acts as a form of stability as it falls when growth is low and rises when growth is higher.  Countries with procyclical currencies are less able to pursue countercyclical monetary policy and are also more vulnerable to financial crises. Countries with countercyclical currencies find it easier to follow monetary policy. Bigger countries that rely on exports and manufacturing and which have procyclical currencies experience so-called “ competitive devaluations” in bad times. 

The Pound 

The pound as a pro-cyclical currency has benefited from global economic growth and robust market sentiment, especially the beginning of this year when the rapid pace of the vaccination program gave investors confidence. More recently, however, it has fallen following signs that the US economy is slowing down. Concerns also for the spread of the Delta variant across the world and particularly Asia, and the possibility of the Federal Reserve reducing its stimulus program have also added more pressure. In a risk off world, where the global economy is weakening, the pound and other pro-cyclical currencies will remain under pressure.

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.