What Is an Exchange Rate — and Why Does It Move Your Shares?

What is an exchange rate?

An exchange rate tells you how many units of one currency you can get in exchange for one unit of another. If GBP/USD is quoted at 1.27, that means £1 buys $1.27 today — and tomorrow that number will almost certainly be slightly different.

Exchange rates float freely in the global foreign exchange market, usually called forex or FX. It is the largest financial market on earth by daily volume, running around the clock across time zones. Nobody sets the rate by decree — it is driven by supply and demand. If global investors want more pounds than usual, the price of the pound rises. If they are selling sterling to buy dollars, the pound falls.

For UK investors, the two most-watched pairs are:

• GBP/USD — nicknamed “cable,” the pound against the US dollar.
• GBP/EUR — the pound against the euro, important for trade with Europe.

You will see these rates reported constantly in financial news, usually alongside FTSE 100 movements — and the two often move in opposite directions for reasons that are worth understanding properly.

Why does the pound’s value matter for your shares?

Here is the key fact: roughly 75–80% of FTSE 100 revenues come from outside the UK, according to FTSE Russell’s index data. Think of the big names in the index — Shell, BP, HSBC, Unilever, AstraZeneca, GSK. They earn billions in US dollars, euros, yen, and dozens of other currencies. But they report their results in pounds.

So when the pound weakens, something interesting happens. Those overseas earnings — earned in dollars or euros — are worth more pounds when converted back. The underlying business has not changed at all, but its profit figure in the annual report goes up. Share prices tend to follow.

The classic relationship: when the pound falls, the FTSE 100 often rises. It is counterintuitive at first — bad news for the currency, good news for the index? But once you understand who earns what where, it makes complete sense.

The reverse is equally true. When sterling strengthens — say, after a positive Bank of England decision — those same dollar and euro profits are worth fewer pounds when converted, and FTSE 100 earnings can come in below expectations even if the underlying businesses are doing well.

A simple worked example

Suppose Shell earns $10 billion from its global operations in a given year. How much is that in pounds? It depends entirely on the exchange rate at conversion.

GBP/USD rate	$10 billion in £	Difference
1.20 (weak pound)	£8.33 billion	—
1.30 (mid rate)	£7.69 billion	−£640 million
1.40 (strong pound)	£7.14 billion	−£1.19 billion

Notice the difference between the weakest and strongest scenario: nearly £1.2 billion — and not a single barrel of oil more or less was produced. The business is identical. Only the currency moved. That is the power of FX on company earnings, and it is why analysts always adjust their profit forecasts when the pound makes a big move.

What makes the pound move?

Interest rate decisions

The Bank of England sets the UK base rate, and it is probably the single biggest driver of sterling in normal times. When the Bank raises rates, holding pounds becomes more attractive to international investors chasing better returns on GBP deposits and bonds. More demand for sterling pushes its value up. When rates are cut, the opposite tends to happen. If you want to understand this chain in more detail, the article on how interest rates affect shares walks through the full logic from rate decision to share price.

Inflation data

High inflation erodes a currency’s purchasing power over time — goods and services get more expensive in sterling terms, which makes the pound less attractive to hold. Inflation data also feeds directly into expectations about what the Bank of England will do next: if CPI comes in higher than forecast, traders may expect rate rises, which can actually lift sterling; if inflation is falling fast, rate cuts look more likely and the pound may weaken. What inflation is and why it matters is covered in full in our Basics section.

Economic growth and confidence

Strong GDP growth figures, healthy PMI surveys (which measure business activity), and rising employment all tend to attract overseas investment into the UK — and that investment has to be paid for in pounds, pushing demand for sterling up. Weak data does the reverse. You will often see the pound tick up or down sharply in the minutes after a major economic release.

Global risk appetite

In times of global stress — financial crises, geopolitical shocks, sudden recessions — international investors tend to flee to safe-haven currencies: the US dollar, Japanese yen, and Swiss franc. These are seen as the most stable and liquid. Sterling, though a major currency, tends to fall in sharp risk-off moments as investors move into dollar-denominated assets. It is not a reflection on the UK economy specifically; it is just where global money flows in a panic.

The FTSE 250: a different picture

Everything above applies to the FTSE 100 — the 100 largest companies on the London Stock Exchange, most of them global giants. But the FTSE 250, the next 250 companies down, tells a very different story.

FTSE 250 companies tend to earn most of their money in the UK. They are more domestic in character: house builders, retailers, regional banks, travel companies. For them, a weaker pound raises the cost of anything they import — raw materials, goods from overseas suppliers, equipment priced in dollars — while their revenues stay in sterling. That squeezes margins.

This means a strong pound can actually be good news for domestically focused firms, even as it hurts the multinationals in the FTSE 100. The two indices genuinely move differently in response to currency shifts.

Challenge tip: before picking a share, check whether the company is a FTSE 100 multinational earning mostly abroad, or a FTSE 250 domestic earner. The FX effect runs in opposite directions — knowing which camp your share is in helps you interpret news correctly.

Importers vs exporters: a quick way to check

A useful mental model is to classify every company you are considering as either an exporter (earns abroad, reports in GBP) or an importer (buys inputs in foreign currency, sells in GBP).

• Exporters — BP, Shell, HSBC, GSK, Diageo — tend to benefit when sterling weakens, because their overseas profits convert back to more pounds.
• Importers — supermarket chains buying food from global suppliers, fashion retailers sourcing clothing in Asia, electronics companies paying for components in dollars — tend to be hurt by a weak pound, as their costs rise while their customers are paying in pounds.

The quickest way to check: look for the geographic revenue breakdown in a company’s annual results or on its investor-relations page. If UK revenue is, say, 15% of the total and the rest is overseas, that company is heavily exposed to currency movements. Most major FTSE 100 companies publish this breakdown clearly, and it takes about two minutes to find.

Using exchange rates in the challenge

In the Student Investor Challenge, you are picking real companies on real markets, so these effects apply to your virtual portfolio just as they would to real money. A few things to keep in mind:

• Ask “Where does this company make its money?” before placing any trade. If you are buying a FTSE 100 multinational and you think the pound is likely to weaken, you have a currency tailwind working in your favour. If you are wrong about sterling, that tailwind turns into a headwind.
• Diversify across home and overseas earners. Holding only FTSE 100 multinationals means your portfolio moves partly in line with the pound, whether you intended that or not. Mixing in some domestic companies provides a natural hedge. The article on diversification explains why spreading your bets matters more broadly.
• Watch Bank of England rate announcements on the economic calendar — these are the single most reliable source of big pound moves in the short term. Knowing one is coming helps you anticipate potential volatility in your multinational holdings.

You do not need to become a foreign-exchange trader. The point is simply to understand that currency movements are already baked into the FTSE 100, even when nobody mentions them. Most days the FX effect is small and quiet. Occasionally — think Brexit, major rate surprises, or a global financial shock — it dominates everything else. Being aware of it means you are never caught wondering why the FTSE 100 jumped 1% on a day when there was no obvious company news.

Frequently asked questions

Does a falling pound always push the FTSE 100 higher?

Often, but not always. Company-specific bad news — a profit warning, a scandal, a costly lawsuit — can easily outweigh the currency tailwind. The relationship is a tendency, not an iron rule. Other forces, from global recession fears to oil price shocks, can overwhelm it on any given day.

How can I tell where a company earns its money?

Look for the geographic breakdown of revenue in a company’s annual results or on its investor-relations page. Most large FTSE 100 companies publish this clearly, split by region: UK, Americas, Europe, Asia Pacific, and so on. If the UK slice is small, that company’s profits are heavily influenced by currency movements.

Can I use exchange-rate forecasts to pick shares?

Professional currency forecasters routinely get it wrong — predicting FX moves is notoriously difficult even for experienced traders with expensive tools. The better use of FX knowledge is to understand the risk already sitting in your portfolio, not to bet on where the pound is heading next.

Why does the Bank of England’s base rate affect the pound?

Higher interest rates attract international investors seeking better returns on GBP deposits and bonds. More demand for sterling pushes its price up. When the Bank of England raises rates, the pound often strengthens; when it cuts, the pound can weaken as investors move money elsewhere for better returns.