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British Pound Could Benefit From Upward Revision in 1Q GDP

British Pound Could Benefit From Upward Revision in 1Q GDP

2010-05-21 21:45:00
David Song, Currency Strategist
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 TOF-10-05-21-04

Fundamental Forecast for British Pound: Neutral

- U.K. Inflation Jumps More Than Expected in April
- Bank of England Votes 9-1 to Maintain Current Policy
- Retail Spending Unexpectedly Increases For Third Month
- Public Sector Borrowing Jumps At Record Pace

The British Pound maintained a narrow range after bouncing back from a fresh yearly low of 1.4239 on Wednesday, and the currency may continue to trend sideways over the following week as investors weigh the outlook for future policy. At the same time, the preliminary 1Q GDP report is expected to show economic activity expanding 0.3% from the fourth-quarter amid an initial projection for a 0.2% rise, and an upward revision in the growth rate may give the Bank of England scope to normalize policy further over the coming months as the recovery gathers pace.

The BoE meeting minutes release earlier this week showed the MPC voted unanimously to hold the benchmark interest rate at 0.50% and maintain its asset purchase target at GBP 200B, while Governor Mervyn King retained a dovish outlook for monetary policy as he expects the “substantial margin of spare capacity” in the real economy to drag on inflation over the medium-term even as price growth exceeds the central bank’s upper limit for the third time this year. Moreover, the central bank said that “near-term inflation prospects had risen, reflecting the depreciation of sterling and higher oil prices,” while “some members interpreted recent developments in firm’s costs and pricing behavior as potentially suggesting that the damping effect on inflation from the margin of spare capacity might be somewhat weaker” as the BoE expects price pressure to hold above the 2% throughout 2010.

Meanwhile, a report by the BoE showed mortgage lending by the major banks in the U.K. slipped to the lowest level in nearly a year, with the central bank stating “estate agent contacts reported that the availability of mortgage finance had continued to suppress demand for houses among first-time buyers,” and the central bank is likely to keep a loose policy stance going into the second-half of the year as it aims to encourage a sustainable recovery. However, Deputy Governor Paul Tucker argued that extraordinary measures taken on by policy makers have “created conditions in which over-exuberance can gain traction,” and went onto say that “the objective of monetary policy should remain on steering nominal demand so as to achieve an inflation target” during a press conference in Frankfurt. Meanwhile, board member Adam Posen said that the debt crisis in the Euro-Zone will certainly “have some disinflationary, some negative drag on the U.K. economy” during an interview in Berlin, and noted that the MPC “needs to pay more attention” to the stickiness in prices as the outlook for growth and inflation improves.

Nevertheless, the British Pound could benefit from the economic events scheduled for the following week as market participants expect an upward revision in the 1Q GDP report paired with a rise in mortgage lending, but risk trends could play a greater role in driving price action as the European debt crisis continues to weigh on investor sentiment. - DS

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