Should You Invest In GBP/JPY?

• Both currencies are part of the elite basket of 7 denominations that underpins the International Monetary Fund’s (IMF) in-house money, the ‘special drawing right’. Japan and the UK are both members of the Group of Seven leading economies.

• The two countries trade extensively with one another and share important interests in economic, diplomatic and security terms.

• Their economies are not only very different, but they are also almost completely out of sync regarding growth and monetary policy.

• Trading opportunities abound across such a divide, but preparation is the key to a successful trading strategy.

Would trading the pound/yen be right for you? Let’s start by looking at the currencies involved.

The yen is the currency of the world’s third-largest economy and is one of the most important denominations.

For much of the post-war period, the Japanese authorities struggled to hold down the value of the yen, which was threatened with upward pressure as a result of the country’s post-war economic miracle. This drew the ire of successive American administrations, which believed Japan was trying to obtain an unfair trade advantage.

Since the onset of the Japanese economy’s successive ‘lost decades’ from the early 90s onwards, the picture has become more nuanced. Explicit attempts by the Tokyo authorities under Prime Minister Shinzo Abe to keep the yen down to stimulate exports have produced much less by way of protest, possibly because compared with the prospect of the huge Japanese economy grinding to a halt, this is seen as the lesser of two evils.

Furthermore, during the last 10 years the yen has been reasonably stable against the dollar, fluctuating between 78 and 122 to the US currency.

The yen-sterling rate has been relatively more volatile during the last 10 years, swinging round from 117 to the pound up to 250, than has the yen-dollar rate. But this may in part be because the main action lies in the yen-dollar trade, with sterling sometimes getting caught in the backwash.

As the smallest of the major reserve currencies, the pound is always vulnerable to sharp movements or long-running trends in trading among the bigger units such as the euro and the dollar.

The significant Anglo-Japanese trading relationship, with the most recent full set of figures showing a UK deficit on trade in goods with Japan of £2.4 billion once imports and exports were taken into account and a surplus on trade in services of £3.2 billion.

The imbalance between the relative sizes of the two economies, Japan’s being larger than that of Britain and Germany combined. This cannot fail to have an impact on the pound/yen trade.

The repeated becalming of Japan’s huge economy in recent years. In its most recent consultation with Japan, the IMF said “the outlook for growth and inflation remains subdued”. This tendency to stagnation has prompted Mr Abe to launch numerous stimulus attempts, which have a direct impact on the value of the yen.

The pound-yen rate’s response in recent years to British domestic political events - dropping at the time of the indecisive 2010 General Election, rising in the wake of the surprise Conservative Party poll victory in 2015 and dropping again after the 2016 European Union referendum result.

Geopolitical tensions in the East Asian region, concerning Japan, Korea and China, will inevitably affect the pound-yen rate.

Interest rates. British rates look set to rise while those in Japan remain at zero. This will be a key influence on the pound-yen rate.

In most cases, a currency pair can be traded in 3 main ways: physically, or through the derivatives market or by using contracts for difference (CFDs).

1. Physical trading involves exchanging one currency for the other, depending on which you expect to perform more strongly, through a trading account with a financial services firm or even through your bank. Actually taking possession of one or other set of banknotes, perhaps, through a bureau de change, is not advised – it is expensive and not very secure.

2. Derivative products such as futures and options give you the chance to take positions on exchange-rate movements without having to own the currency itself. But this can be expensive if the rate moves significantly away from where you thought it would be.

3. Contracts for difference have grown enormously in popularity in recent years as a simple and cost-effective way to trade on financial markets. A CFD is a contract between a trader and a broker to pay each other the difference between the price of an asset when the contract was signed and the price on the day that the contract is terminated. They are leveraged products, meaning you can gain exposure by investing only a percentage of the full value of the trade you want. Whilst this gives opportunity for greater profit, you risk losing more than your deposit if the market moves against you. A second risk is that rapid price changes can cause your account balance to change quickly. If you do not have enough funds in your account to cover these situations, there is a risk your position may be closed automatically when your balance falls below a certain level, known as the close-out level. Stop-orders can limit risk but, in fast moving markets, prices might rise above or fall below the desired level before a sale can be executed. This may increase losses.

eToro offers CFD trading on the pound and the yen

These are two of the world’s most important currencies, issued by two friendly countries with an extensive trading relationship and a shared commitment to market economics and the rule of law. But the linkages between the pound and the yen are far from straightforward and a firm grasp of them is essential for successful trading.