Is The GBP & FTSE100 Correlated?
The correlation between the GBP and the FTSE100 has caused some investors and traders to scratch their heads. This video explains it...
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We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
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We have a question from Niroshan who asks that we explain the relationship between the FTSE100 and the British Pound, is there a correlation between them?
The correlation between the GBP and the FTSE100 has caused some investors and traders to scratch their heads from time to time, especially over the past four years due to massive disruptors like Brexit, a broad-based stronger Dollar and things like the Coronavirus of course.
Let’s start by looking at the most common correlation between the GBP and the FTSE100, which is actually an inverse correlation, and with this we actually need to be a lot more specific in that the inverse correlation relationship between these two are mainly on the GBPUSD versus the FTSE100 and not the Pound in general versus the FTSE100, but the GBPEUR exchange rate can also have an impact, so let’s look at why this is.
Schroder.com provided a fantastic illustration a while back in an article that explains the inverse correlation quite well, and it all comes down to dollar-denominated revenues for the heavyweight companies in the FTSE100 index.
The outer ring of this illustration is the important one because it shows you the regions where FTSE100 companies generate their revenues from, and you’ll notice that 71% of their revenues are generated outside the UK. So, even though 97% of FTSE100 companies are domiciled in the UK, the bulk of their revenue is generated outside the UK, which is why the GBPUSD exchange rate is important for these companies.
So, going to the charts, a good example of this inverse correlation in play was just after the Brexit referendum in 2016 and early 2017 when the GBP of course fell off a cliff, but even with Brexit uncertainty running rampage on the GBP we saw the FTSE100 increase quite substantially over the same time horizon, seeing that inverse correlation in play, and this was really mainly driven by the fall in the GBP, not only versus the USD, but also versus the other major partners, so if we go back to that illustration, the fact that the GBP fell against all of these outer circle currencies meant lots of increase in revenue just due to the exchange rate itself.
So, any massive sudden surges in the GBP, whether up or down, can have quite an impact in the FTSE100 heavyweight companies just simply due to their dependency of revenues from outside the UK, mostly dollar-denominated revenues.
Now, there are also times when there is a strong correlation between the GBP and the FTSE100 instead of an inverse correlation. So, going back to that chart, if we just fast forward this chart from April 2017 onwards, we haven’t really seen that strong inverse correlation, we’ve actually see the GBP and the FTSE100 moving more correlated with each other, so what could have been the reasons for this.
Well, during 2017 the Dollar saw lots of downside as the rest of the world was performing quite well, that downside in the Dollar sent the GBP higher, which should have weighed on the FTSE100, but the fact that growth and inflation prospects were rising at that time meant that the FTSE100 moved higher on the back of that despite the GBPUSD strength.
Fast forward that another year and we saw that the Dollar saw upside versus almost all other major currencies in 2018, partly because the FED was one of the only central banks hiking rates at that time while other major central banks were entering easing territory, which provided upside for the USD versus most majors including the GBP, now based on the previous example we looked at why didn’t the weaker GBPUSD provide any meaningful upside for the FTSE100 at that time?
Well, the whole world, apart from the United States, was moving out of a period of economic expansion and was showing more and more signs of slowing, which meant that even with a weaker GBPUSD the FTSE100 still moved lower due to growth and inflation concerns.
So, you see, that it’s not just about the relationship these two share with each other from a company revenue point of view, but also from a Dollar point of view and a global economy point of view, like we’ve mentioned a few times, it’s never just one thing but always a whole range of factors that influence prices, but knowing about some of the common correlations or inverse correlations can be helpful to make sense of the moves, but at the same time these examples are a great reminder that correlation does not mean causation.
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If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
-----
We have a question from Niroshan who asks that we explain the relationship between the FTSE100 and the British Pound, is there a correlation between them?
The correlation between the GBP and the FTSE100 has caused some investors and traders to scratch their heads from time to time, especially over the past four years due to massive disruptors like Brexit, a broad-based stronger Dollar and things like the Coronavirus of course.
Let’s start by looking at the most common correlation between the GBP and the FTSE100, which is actually an inverse correlation, and with this we actually need to be a lot more specific in that the inverse correlation relationship between these two are mainly on the GBPUSD versus the FTSE100 and not the Pound in general versus the FTSE100, but the GBPEUR exchange rate can also have an impact, so let’s look at why this is.
Schroder.com provided a fantastic illustration a while back in an article that explains the inverse correlation quite well, and it all comes down to dollar-denominated revenues for the heavyweight companies in the FTSE100 index.
The outer ring of this illustration is the important one because it shows you the regions where FTSE100 companies generate their revenues from, and you’ll notice that 71% of their revenues are generated outside the UK. So, even though 97% of FTSE100 companies are domiciled in the UK, the bulk of their revenue is generated outside the UK, which is why the GBPUSD exchange rate is important for these companies.
So, going to the charts, a good example of this inverse correlation in play was just after the Brexit referendum in 2016 and early 2017 when the GBP of course fell off a cliff, but even with Brexit uncertainty running rampage on the GBP we saw the FTSE100 increase quite substantially over the same time horizon, seeing that inverse correlation in play, and this was really mainly driven by the fall in the GBP, not only versus the USD, but also versus the other major partners, so if we go back to that illustration, the fact that the GBP fell against all of these outer circle currencies meant lots of increase in revenue just due to the exchange rate itself.
So, any massive sudden surges in the GBP, whether up or down, can have quite an impact in the FTSE100 heavyweight companies just simply due to their dependency of revenues from outside the UK, mostly dollar-denominated revenues.
Now, there are also times when there is a strong correlation between the GBP and the FTSE100 instead of an inverse correlation. So, going back to that chart, if we just fast forward this chart from April 2017 onwards, we haven’t really seen that strong inverse correlation, we’ve actually see the GBP and the FTSE100 moving more correlated with each other, so what could have been the reasons for this.
Well, during 2017 the Dollar saw lots of downside as the rest of the world was performing quite well, that downside in the Dollar sent the GBP higher, which should have weighed on the FTSE100, but the fact that growth and inflation prospects were rising at that time meant that the FTSE100 moved higher on the back of that despite the GBPUSD strength.
Fast forward that another year and we saw that the Dollar saw upside versus almost all other major currencies in 2018, partly because the FED was one of the only central banks hiking rates at that time while other major central banks were entering easing territory, which provided upside for the USD versus most majors including the GBP, now based on the previous example we looked at why didn’t the weaker GBPUSD provide any meaningful upside for the FTSE100 at that time?
Well, the whole world, apart from the United States, was moving out of a period of economic expansion and was showing more and more signs of slowing, which meant that even with a weaker GBPUSD the FTSE100 still moved lower due to growth and inflation concerns.
So, you see, that it’s not just about the relationship these two share with each other from a company revenue point of view, but also from a Dollar point of view and a global economy point of view, like we’ve mentioned a few times, it’s never just one thing but always a whole range of factors that influence prices, but knowing about some of the common correlations or inverse correlations can be helpful to make sense of the moves, but at the same time these examples are a great reminder that correlation does not mean causation.
-----
If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
