As Carl Delfeld at ETF XRAY and Tom Lydon at ETF Trends have recently discussed, the pound has appreciated considerably in recent months as a result of persisting inflation in the British economy.  Although the results of such currency appreciation can be mixed depending on trade deficit in an economy, the general consensus has been that this should provide an overall boost to the ETF's holdings despite a trade deficit of approximately 4.3 billion pounds.  In order to better determine the historical relation between the Pound and the iShares MCSI UK Index, I have analyzed the return correlation of a number of relevant variables.

To see how the iShares MCSI ETF and the Pound behave, I analyzed the following time series from April 1, 1996 to April 22, 2007:

• iShares MCSI UK Index (EWU)

• Trade-Weighted Pound Index

• Pound-Dollar Rate

• Pound-Euro Rate

    As can be seen from the graph, there is an obvious difference in the magnitude of the growth between the iShares ETF and the Pound itself.  Although the two appear to move roughly together, the difference in magnitude makes this somewhat harder to see.  In order to better determine the connection between the Pound rate and EWU, I calculated the daily, 3-month, and 12-month correlations. 

    These results make it pretty clear that if you see a strong Pound, the iShares MCSI UK ETF is a good bet. The ideal situation for this ETF would be for the Pound to continue to appreciate against the dollar, while at least holding its own against the Euro. Though Tricky Trichet might be hard to read, it seems as if this best-case condition might hold at least through the coming year.