Pound May Plot New Direction If Inflation Report Influences BoE

GBP/USD

The British pound came under pressure today after Fitch Ratings said the U.K.’s sovereign credit rating is most at risk among AAA rated nations. Sterling had previously set a three month high and was looking to extend its gains as support for the currency has been driven by the BoE refraining from adding to its asset purchase program. Interest rate expectations continue to have a moderate impact on price direction, currently explaining 21% of volatility. The cable was also bolstered by rising equity markets which still explain 25% of price action, despite diminishing in importance. The GBP/USD’s correlation to stocks has declined from 36% a months ago which will have start to take a look at other potential drivers, such as inflation in the upcoming weeks.

BOE Interest Rate Expectations

Overnight index swaps are currently pricing in 80 bps worth of rate hikes over the next twelve months from the BoE, down from 95.4 on 11/5. The MPC adding less than expected to their to its quantitative easing efforts and signaling that further efforts may not be needed helped lift the outlook for interest rates temporarily. Then this past weekend’s pledge from G-20 members to maintain the current accommodative environment sent yield expectations lower across the board. Former BoE member David Blanchflower who warned of the U.K.’s recession continues to call for more stimulus efforts from the central bank as the economy remains at risk for a double dip recession. The ultra-dove is calling for additional spending in the asset purchase program which currently sits at £200 billion. If we see interest rate expectations continue to decline then more sterling weakness could be ahead. Tomorrow’s employment figures and inflation report should have an influence on future monetary policy and p[resent potential event risk Visit the GBP/USD Forum to discuss BoE monetary policy and other topics.

FOMC Interest Rate Expectations

The extension of the $8,000 tax credit for new homebuyers is expected to be the first of several stimulus measures that will see life beyond their initial time frame. Unemployment reaching 10.2% last month has significantly lowered the outlook for domestic growth which may the Fed to remain on hold throughout all of next year. We have seen the chances for a 50 bps rate hike in January decline to 6.8% from 26.7% according to Fed Fund futures. The longer timetable for the central bank to begin its exit strategy may continue to have a weighing influence on dollar sentiment. The greenback has become the funding currency of choice making it susceptible to weakness when risks appetite rises.

Risk

Equity markets have consolidated yesterday’s gains after rallying for six straight days, as traders await the next catalyst. There is still potential upside as the Dow has yet to retrace 50% of its losses from its peak before the crisis. We could see traders target the level which is at 10,326 before potentially retracing recent gains. It is widely expected that a significant pullback is ahead , as rising unemployment and weak domestic spending are expected to continue which will bring current valuations into question. Risk appetite has seen its influence decline over the pound, but with a 25% correlation it still bears watching.

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