British Pound / US Dollar Monthly Technical Forecast

British Pound / US Dollar Monthly Technical Forecast
12/9/2009                    Monthly Chart


Our outlook for the pair remains well intact with the market adhering to the multi-month consolidation after failing ahead of 1.7000 and rolling back over into the well defined range. Look for an eventual break below 1.6250 to open the door for some deeper setbacks over the coming weeks towards next key medium-term support by 1.5705. In the interim, below 1.6250 will expose initial previous resistance turned support by 1.6130. Rallies should now be well capped ahead of 1.6800, with only a clear break back above this psychological barrier to delay outlook.


 
British Pound / US Dollar Interest Rate Forecast

U.S. and U.K. interest rate expectations are nearly identical with the spread at +2 in the sterling’s favor. Therefore, it isn’t a major surprise to see that the pair has remained relatively range bound over the past month. Unlike many of the other major crosses the GBP/USD hasn’t seen the same high level of correlation between risk trends. The BoE continuing to add to their quantitative easing efforts has led to the divergence, which could continue until the central bank officially brings an end to it.

The upcoming MPC interest rate decision could see such an announcement which could alter the direction of future price action. Sterling support could be generated if the end of the asset purchase program raises the outlook for interest rates. Despite the pair’s relatively small correlation with risk, trends must be monitored for their impact on greenback sentiment as long as the reserve currency holds onto its funding status.


British Pound / US Dollar Valuation Forecast

GBPUSD Valuation Forecast: Bearish

The British Pound has turned lower over the previous month, becoming a bit less overvalued against the US Dollar. Still, positioning suggests that prices have ample room to decline with GBPUSD trading 1294 pips above its “fair” exchange rate. In percentage terms, however, sterling is only 7.46% above where PPP would suggest that it should be, making the UK unit the least overvalued of the majors against the greenback. On balance, this means that bearish valuation pressures are relatively lower here than with other major European currencies like the Euro or the Swiss Franc. The rates outlook is not as forgiving, however: the spread between March 2010 and December 2010 90-day UK interest rate futures (a reflection of the market’s outlook for BOE monetary policy next year) compared with the analogous spread for US Fed Funds contracts has seen the Pound’s expected yield advantage narrowing steadily since early November, which resulted in a lower sterling since about that time. This makes sense: Mervyn King and company have extended quantitative easing measures at the latest monetary policy meeting while the Fed has moved in the opposite direction by scaling back some similar programs and ending others. This suggests that despite a relatively benign overvaluation, GBPUSD is likely to continue heading lower.


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.