gbp fundamentals

British Pound US Dollar Exchange Rate Forecast

Tuesday, 07 July 2009 05:36:19 GMT  |  Joel Kruger, Technical Currency Strategist; David Rodriguez, Quantitative Strategist; Ilya Spivak, Currency Analyst

British Pound / US Dollar Monthly Technical Forecast



Gains are stalling out by the 61.8% fib retracement off of the 1.8670-1.3500 September 2008-January 2009 move and with weekly stochastics still showing overbought, our bias tends to favor the downside. Fresh 2009 highs by 1.6745 could not be sustained and the result has been a sharp reversal to set up a bearish weekly close in early July. A break below 1.6185 will however be required to accelerate declines and confirm the medium-term topping structure. Below 1.6185 will accelerate declines to 1.5800, which ultimately guards against a full fledged resumption of the broader downtrend. Only a weekly close back above 1.6745 will negate and give reason for pause.


British Pound / US Dollar Interest Rate Forecast



The British Pound/US Dollar exchange rate has shown little sensitivity to interest rate forecasts, and we predict financial risk sentiment will continue to be the major driver of GBPUSD price action. Indeed, the short-term correlation between the GBPUSD and US S&P 500 Index remains near record-highs—emphasizing that the exchange rate has moved almost exactly in tandem with risk sentiment. Overnight Index Swaps predict that the British Pound-US Dollar yield differential will likewise remain nearly unchanged.

It will be far more significant to monitor shifts in unconventional monetary policy measures. Both the Bank of England and the US Federal reserved have engaged in aggressive Quantitative Easing plans. Any abrupt changes to these programs could cause substantial GBPUSD volatility.


British Pound / US Dollar Valuation Forecast



The British Pound remains substantially overvalued compared to its PPP-implied exchange rate on the heels of a rebound in risk appetite that has weighed heavily on the safety-linked US Dollar. The prevailing outlook for economic growth appears to favor the greenback, with a survey of economists conducted by Bloomberg suggesting the US will outperform the UK by an average of 0.9% through 2010. Notably, the States’ expected growth advantage has been trimmed from last month’s assessment, where it stood at 1.4%. In the near term, risk appetite will likely retain the upper hand in guiding price action with GBPUSD 90.7% correlated with the MSCI World Stock Index (using a 90-day rolling correlation) and positioning seemingly supportive of safety-related assets. Looking farther ahead, interest rate expectations remain roughly balanced and could mean the Pound’s weakness against the Dollar is shorter-lived than that of the Euro.

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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