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GBPUSD: British Pound US Dollar Exchange Rate Forecast

GBPUSD: British Pound US Dollar Exchange Rate Forecast

2011-07-07 00:11:00
Joel Kruger, David Rodriguez, Ilya Spivak,
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British Pound / US Dollar Technical Forecast

Weekly Chart

GBPUSD_British_Pound_US_Dollar_Exchange_Rate_Forecast_body_EURJULY.png, GBPUSD: British Pound US Dollar Exchange Rate Forecast

Prepared by Joel Kruger

The market had been in rally mode for much of 2011 before finally starting to find some offers ahead of critical medium-term resistance in the 1.7000 area over the past two months. Look for the latest break below the 200-Day SMA to act as a catalyst for deeper setbacks ahead with weakness now seen back below 1.5750 and towards 1.5500 over the coming weeks. Ultimately, only back above 1.6500 gives reason for concern.

British Pound / US Dollar Interest Rate Forecast

Currency, Central Bank

British Pound,Bank of England

US Dollar, US Federal Reserve

Net GBPUSD Spread

Signal

1-Year Expectations(Basis Points)

20

16

4

Bullish

Yield in 1 Year(Percent)

0.70

0.41

0.29

Bullish

GBPUSD_British_Pound_US_Dollar_Exchange_Rate_Forecast_body_Picture_6.png, GBPUSD: British Pound US Dollar Exchange Rate Forecast

British Pound / US Dollar Interest Rate Trading Bias: Neutral

Bank of England and US Federal Reserve interest rate expectations have hit significant lows, having little net effect on the British Pound/US Dollar currency pair. The British Pound had previously benefited from speculation that the Bank of England would move to raise rates as inflation remained well-above target. Yet a hawkish minority within the BoE’s policy-setting Monetary Policy Committee failed to gain traction, and the majority of central bank officials favor keeping rates unchanged through the foreseeable future.

The Bank of England seems far more concerned with poor growth prospects than well-above target Consumer Price Index inflation. Unless BoE officials show any signs of urgency in tightening monetary policy and raising rates, yields will provide little support to the downtrodden British Pound.

British Pound / US Dollar Valuation Forecast

GBPUSD Valuation Bias: Bullish

GBPUSD_British_Pound_US_Dollar_Exchange_Rate_Forecast_body_07062011_JPY.png, GBPUSD: British Pound US Dollar Exchange Rate Forecast

The Pound remains the least overvalued major currency against the US Dollar, trading at 10.3 percent above its PPP-implied fair exchange rate. The Bank of England appears determined to keep interest rates at post-2008 crisis lows despite a run-up in headline inflation, which ought to prove easier now with the departure of lead hawk Andrew Sentence from the rate-setting MPC committee. This makes any correction lower a USD-driven affair, with much to be decided by the degree to which US yields recover after the expiry of QE2.

Upward pressure on borrowing costs from the need to finance the gaping US budget deficit will be counterbalanced by increasing weakness in US economic data, with the winning side of this tug-of-war as yet unclear. With that in mind, the greenback may yet find strength in safe-haven demand if the global economic slowdown now underway proves especially severe. Finally, the breakout of renewed sovereign stress in the Euro Zone may underpin Sterling as a regional alternative if confidence is shaken in the single currency. On balance, while overall positioning is bearish, it seems premature to enter short for the time being.

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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