Fundamental Outlook for British Pound: Bearish

- Financial crisis raises fears that another UK bank will fail
- Retail spending indicator hits record low, BoE official warns recession may be on the way
- A housing recession deepens as mortgage approvals hit a record low

The health of the financial markets will determine the pound’s future – not just in the days ahead, but for weeks and months. The bailout plan from the US will certainly have a bearing on the UK economy and therefore its currency; but the roots of the year-long credit problem grow a little deeper than just this recent (though crippling) crisis. Should US politicians drop the ball with this proposal, each economy’s currency will be judged on its exposure to the fallout that will no doubt follow – and the UK is certainly positioned to receive the worst of its thanks to its position as the financial center of the world. However, even if the US gives the global credit market that much needed booster shot of confidence, the United Kingdom could still suffer from credit woes and broader economic malaise.

While a total evaporation of liquidity from the credit markets is a far worse scenario for Britain, the economy is already suffering from its own localized credit crunch. British consumers are among the most indebted in the world and a record breaking housing boom has just begun to collapse on itself. As economic growth cools and lending grows more restrictive (and banks will remain cautious for some time whether the crisis is immediately lifted or not), the drop in consumer confidence and spending will accelerate the approaching recession. These concerns have already been reflected in rate expectations with overnight index swaps pricing in more than 100 basis points of cumulative easing over the coming 12 months. Nonetheless, conditions can grow to be much worse. On this point, there are three rounds of data to watch. Monday brings the August readings of net consumer credit and mortgage approvals – measuring Brits’ access and tolerance to lending. On Friday, the second quarter housing equity withdrawal report will show not only how much citizens are willing to borrow, but also how much they are able to borrow. And, finally, the most encompassing report will be the BoE’s third quarter credit conditions survey. This will go to the root of the problem and give a forecast rather than a wrap up – what any fundamental trader really wants.

Apart from credit, the market will further receive a general overview of economic health from all of the UK’s major sectors. The health of the consumer will be measured through the GfK consumer confidence survey for September. For the ever-evolving housing depression, there will be the delayed Nationwide House Price indicator. And, to round things out are the September construction, manufacturing and service sector PMI figures. It shouldn’t surprise anyone that all of the aforementioned indicators are expected to drop. Finally, in a symbolical gesture, the final reading of 2Q GDP is due Tuesday; and an unexpected tip into negative territory could really trigger bearish concerns.

Antonio Sousa is a Currency Analyst for FXCM.