gbp fundamentals

British Pound - US Dollar Exchange Rate Forecast

Tuesday, 03 February 2009 18:39:01 GMT  |  Jamie Saettele, Senior Currency Strategist; David Rodriguez, Quantitative Analyst; Ilya Spivak, Currency Analyst

British Pound - US Dollar Monthly Technical Forecast

The drop below 1.3680 satisfies minimum expectations for the expanded flat that began in 1992. It is possible that 1.35 is the bottom that will hold for months and maybe even years. Staying above 1.4049 keeps the 'major bottom' scenario intact. Additional evidence that bulls can cite is the position of monthly RSI, which is at its lowest levels since the 1976 bottom.

British Pound - US Dollar Interest Rate Forecast

The British Pound has fallen substantially against the US Dollar through recent months, and an aggressive contraction in the GBP/USD yield differential has played a large part in said declines. The US Federal Reserve slashed interest rates to their lowest levels on record-boosting the GBP's rate advantage against its US counterpart. Yet the British Pound likewise saw its once-impressive yields fall sharply on aggressive Bank of England monetary policy easing. Though the GBP maintains a marginal yield advantage against the US Dollar, Overnight Index Swaps forecast that the slight advantage will be almost completely erased in a year's time.

Traders and analysts predict that the Bank of England has not yet finished cutting rates in its current monetary policy accommodation cycle-reducing the attractiveness of the British Pound. 1-Year swaps call for a further 45 basis points in BoE cuts, while the Federal Reserve is expected to raise rates by a roughly equivalent 51 basis points. Said OIS levels suggest that the GBP/USD rate differential will fall to a meager 0.29bp. The British Pound has arguably remained one of the most interest-rate sensitive currencies in the forex world, and these predictions provide a fairly clear bearish bias for the GBP/USD in the medium to longer term.

British Pound - US Dollar Valuation Forecast

The British Pound dropped into undervalued territory against the US Dollar in January and has scope to widen the imbalance before a meaningful bullish correction takes hold. Although the greenback's expected yield advantage has been eroded by a noteworthy 29% as traders pared back expectations of rate hikes from the US Federal Reserve, the Dollar is likely to continue to see considerable buying interest as eroding global demand weighs on earnings, punishes stock markets, and rekindles risk aversion. On balance, it is important to consider that the Pound performed rather impressively in January amid a broad-based Dollar rally, losing just -0.94% against the greenback whereas the Euro and the Franc both dropped over 8%. With this in mind, we remain neutral and will look to exploit more clear-cut valuation extremes elsewhere.

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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