gbp fundamentals

British Pound Forecast Remains Bearish on Bank of England Rate Prospects

Saturday, 01 November 2008 00:43:16 GMT  |  David Rodriguez, Quantitative Analyst

The British Pound finished modestly higher against the US Dollar through the end of week trade, but its failure at key support raises questions as to the probability of further British Pound recovery. 

Fundamental Forecast for the British Pound: Bearish

- British Pound faces gloomy outlook on Bank of England rate cuts
- UK Nationwide Home Prices fall by most on record

The British Pound finished modestly higher against the US Dollar through the end of week trade, but its failure at key support raises questions as to the probability of further British Pound recovery. The Sterling was able to make an impressive 9.2 percent rebound off of recent six-year lows, but in doing so the GBP/USD reached and quickly reversed off of key Fibonacci retracement levels through the week’s close. The technical picture tells us that the British Pound could continue its declines, and expectations for deterioration in UK fundamentals likewise pose a threat to the GBP.

The coming week of event risk may further dampen trader optimism for the British Pound, as the Bank of England is widely expected to cut rates substantially through its Thursday meeting. The median analyst forecast calls for a 50 basis point cut by the UK central bank, but some are calling for as much as an incredible 100 basis points in easing. Certainly the fact that the UK saw sharply negative GDP growth in the third quarter supports the case for monetary policy easing, but it is unclear that the BoE will move rates so sharply. According to over-the-counter Overnight Index Swaps, traders have priced in near-certainty of a 75 basis point move by the BoE. Though it is obviously difficult to predict exactly what will happen following the rate announcement, rate cut and signals that they will continue cutting rates would likely force further declines in the previously high-yielding GBP.

An otherwise lackluster economic calendar promises little in the way of market-moving events for the British Pound, and the currency is more likely to trade off of movements in global risky asset classes. A study of interest rates and currency market movements shows that major currencies have moved almost exactly in line with their short-term interest rates through recent trade. That is to say, the highest-yielding currencies have been the biggest losers through ongoing market turmoil. Given that the British Pound was just recently one of the highest-yielding G10 currencies, we would expect it to continue to move in line with broader financial market activity. Any renewed losses in global equity markets would likely produce selling in the British currency.

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