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As Economy Stumbles, British Pound to Fall with It

As Economy Stumbles, British Pound to Fall with It

2012-07-27 23:05:00
Christopher Vecchio, CFA, Senior Strategist
Share:
As_Economy_Stumbles_British_Pound_to_Fall_with_It_body_Picture_5.png, As Economy Stumbles, British Pound to Fall with It

Fundamental Forecast for British Pound: Bearish

The British Pound had a mediocre week overall despite its 0.79 percent advance against the US Dollar, as it was the third worst performing major since July 20. The Sterling trailed the top performer, the Euro, by 0.55 percent, and the resilient New Zealand Dollar by 0.45 percent. Thus, while the British Pound was not that much lower against the top performers into the end of the week, we still find that this week’s price action is indicative of further declines: a very positive for risk-appetite at the end of the week barely elevated the Sterling. When considered in context of the data delivered this past week, and in conjunction with the data due for the week ending August 3, our British Pound forecast is unquestionably bearish.

In review: UK GDP contracted by a significant -0.7% in the second quarter on a quarterly-basis, more than double the -0.3% contraction in the first quarter and three and a half times worse than the expected print of -0.2% (with a standard deviation of 0.1%, this was a whopping 5 standard deviation miss!). Likewise, on a yearly-basis, growth contracted by -0.8%, well-below the -0.3% prior and expected figures. The British economy has now contracted four of the past five quarters and five of the last seven quarters overall. The British economy is weak, it is weakening, and as expected, the Bank of England’s quantitative easing has done little to help.

For a moment, let’s look past the second quarter GDP data from the week prior and examine what’s due in the week ahead. On Monday, Mortgage Approvals for June are due, and are expected to pullback slightly from June’s figure at 48.0K forecasted from 51.1K. On Wednesday, July’s PMI Manufacturing print is due, and that is expected to show a more intense contraction at 48.4 from 48.6. These are the negative data. On Thursday and Friday, respectively, July’s PMI Construction and PMI Services are due, and both are expected to show modest gains. PMI Construction is expected to have increased to 48.7 from 48.2, which means contraction is evident but at a slower pace; and PMI Services is expected to have increased to 51.6 from 51.3, which means growth is evident at a faster pace.

The aforementioned data, on the whole, are negative and thus the fundamental data outlook this week leads us to a bearish conclusion for the British Pound. Yet one key event remains: the Bank of England Rate Decision and Asset Purchase Target allocation on Thursday.

The Bank of England will keep its key rate on hold at 0.50% as it has since March 2009 (coincidentally, the low in global equity markets), and the Asset Purchase Target will remain at £375 billion. But in light of the second quarter GDP figure (-0.7% q/q, -0.8% y/y), we believe that if nothing changes, this could actually be viewed as a negative event for the British Pound. Paradoxically, the announcement of more easing from the Bank of England should infer lower rates and thus reduce the Sterling’s yield; but in this case, it would show that policymakers are acting swiftly to help boost the British economy’s prospects, which raises the long-term prospect for British Pound (hence we could see some pricing in of better data expected). Accordingly, given this policy decision (or more aptly put, indecision), there’s very little on the horizon that could be viewed as supportive of the British Pound going forward, leading us to a bearish bias for the coming week. –CV

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