08.01.09 GBP

British Pound Volatility Ahead on BOE Rate Decision, Equities Reversal

Fundamental Forecast for British Pound: Neutral

- Buyers Returning to UK Housing Market, Says Hometrack
- GfK Says UK Consumer Confidence Unchanged in July
- UK Mortgage Approvals Rise to Highest in 14 Months

The British Pound is all but guaranteed a week of heavy volatility as the busy economic calendar headlined by a pivotal interest rate announcement from the Bank of England is compounded by hints of a downward reversal in risk appetite. An actual change in benchmark borrowing costs is effectively off the table for the central bank, but traders will be closely watching to see if policymakers choose to ramp up quantitative easing measures after promising to “review the scale” of the program for the August rate decision in conjunction with the release of their quarterly inflation report. Despite the BOE’s apparent optimism and signs of stabilization in some leading indicators, economic growth disappointed in the second quarter, bolstering dovish arguments from the likes of the British Chamber of Commerce and the Shadow Monetary Policy Committee (a group of independent economists that meet at the London-based Institute of Economic Affairs). A timely GDP estimate tracking the pace of economic growth in the three months through July from the National Institute of Economic and Social Research (NIESR) will help set the tone for the monetary policy announcement: while usually quite good at estimating official economic growth figures, NIESR missed the mark in the second quarter having called for output to shrink just -0.4% only to be faced with a -0.8% result; this time around, the prestigious think tank will have likely identified the reason for their previously over-optimistic reading and may offer valuable insight on potentially overlooked weaknesses in the UK economy.

The remainder of the economic calendar is comparatively considering the themes behind further marginal improvements in PMI and Industrial Production are likely to have already been priced into the exchange rate while signs of moderating turmoil in the property market expected to be reported by Halifax have been adequately telegraphed by the latest Hometrack Housing Survey and the Rightmove House Prices report. Indeed, only a meaningful downside surprise in these metrics is likely to prove particularly market-moving, as the trajectory of stock prices and 12-month interest rate expectations (derived from trading in overnight index swaps) over recent months suggest traders are surely looking for the recession to begin to bottom.

Turning to risk sentiment, technical positioning is hinting that the equities rally that began in March is starting to run out of momentum and may be on track to putting in a double top at the October 2008 swing high, with volumes steadily declining since early May and clear negative divergence between rising prices and stalling relative strength studies. A trade-weighted average of the Pound’s value against a basket of major currencies is now over 83% correlated with the MSCI World Stock Index, suggesting sterling will be dragged along if stock markets do indeed turn lower. That said, US news has been the key fundamental catalyst in setting the trajectory of risk-related assets, and expectations of modest improvements for nearly all of the scheduled releases on the US calendar point to smooth sailing for equity markets (barring any significant downside surprises on key metrics or a particularly disappointing second-quarter earnings outcome from a major company).