gbp fundamentals

British Pound/US Dollar Exchange Rate Forecast

Monday, 22 December 2008 19:56:01 GMT  |  Jamie Saettele, Senior Strategist; David Rodriguez, Quantitative Analyst; Ilya Spivak, Currency Analyst

British Pound/US Dollar Long-Term Exchange Rate Technical Forecast

I am expecting the GBPUSD to hold above 1.4554 and advance steadily, possibly to 1.6696 (38.2% of 2.0162-1.4554 and 4th wave of one less degree extreme). This level intersects with Elliott channel resistance in early March. Short term bullish prospects are bolstered by formation of an an inverse and shoulders pattern.

British Pound/US Dollar Exchange Rate Interest Rate Forecast

The British Pound/US Dollar exchange rate has rallied considerably as of late, as record-low US interest rates have led many traders to sell the US currency against high-yielding counterparts. Given that Bank of England target rates currently stand at 1.75 percentage points against their US Federal Reserve counterparts, traders stand to receive a healthy carry if they buy the British Pound against the US Dollar. Yet interest rate expectations hardly favor the British currency; interest rate speculators predict that the Bank of England will cut rates aggressively in the coming 12 months. Such predictions leave the GBP at a clear disadvantage and go a long way in explaining Sterling weakness.

The British Pound was previously one of the highest-yielding currencies of the G10, and that fact made it one of the most sought-after major currencies across forex markets. Yet previous high-yielders have been punished through the second half of the year, as speculative capital has fled these currencies en masse. Given the Bank of England's aggressive interest rate cuts to date, the British Pound is arguably less susceptible to short-term flare-ups in financial market tensions. All the same, bearish interest rate outlook will continue to haunt the currency absent a noteworthy improvement in British economic fundamentals.

British Pound/US Dollar Exchange Rate Valuation Forecast

British Pound/US Dollar Valuation Forecast: Neutral

 

The British Pound has seen heavy selling pressure in recent months. Indeed, the sterling was the only major currency to register loses against the US Dollar in December, putting GBPUSD just over 100 pips off purchasing power parity. However, the pair may overshoot as it corrects lower as the markets continue to price in at least 100 basis points in additional rate cuts from the Bank of England. Still, this is comparatively lower than the greenback's expected yield advantage against most top currencies, suggesting the Pound may be looking for a bottom in the near to medium term.

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 the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.

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