gbp-usd
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The GBPUSD rallied sharply following the head and shoulders breakdown. The minimum head and shoulders objective of approximately 1.5200 was not reached. For now, the pair remains in a large range but with a downside bias as determined by the potentially completed A-B-C advance from 1.3500. 1.4855-1.5075 is a potential support zone.
The British Pound/US Dollar has become increasingly sensitive to interest rate developments, and we expect this will continue into the foreseeable future. Speculation over the future of Bank of England monetary policy has had an especially large impact on all British Pound currency pairs. This is especially true for any and all shifts in BoE Quantitative Easing measures, and any unexpected surprises from the British central bank would likely force substantial GBP/USD volatility.
As it stands, both central banks are expected to raise rates by similar amounts in the coming 12 months. Such neutral forecasts give us no real interest rate-based bias on the GBP/USD.
The British Pound managed to correct higher in October after suffering crippling losses in the previous two months, with the currency now 1580 pips above its PPP-implied “fair” exchange rate. The currency’s correlation to risk sentiment (as tracked by the MSCI World Stock Index) has faded, while the between cable and a Credit Suisse gauge of traders’ priced-in 1-year yield expectations has remained fairly strong. With markets now pricing a BOE that is more aggressive than its counterparts at the Fed for the first time in a month, sterling may remain supported in overvalued territory for now, though November’s interest rate announcement from Mervyn King and company presents considerable event risk as many market observers (including former BOE policy board member David Blanchflower) expect a dovish shift on the UK central bank’s asset-buying program to be announced in tandem with an updated inflation forecast. On balance, the outlook is bearish from a pure valuation standpoint but it seems prudent to remain on the sidelines for the time being.
What is Purchasing Power Parity?
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.
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