Fundamental Outlook for British Pound: Bearish

- Another UK bank is nationalized. Has the financial crisis retrenched in Europe?
- A full credit check for the UK suggests economy set for technical recession
- Interest rate and technical outlook point to further pound losses

The focus on financial crisis has been magnified for the UK this past week – and the close look may mean a new leg of declines for the British pound. A quick recap of the data this past week shows that mortgage approvals hit a record low, second quarter housing equity withdrawals contracted for the first time in nearly a decade and the third quarter BoE credit conditions survey reported the lending environment would only worsen in the near term. No doubt all of this was borne from the biggest housing boom and credit bubble for the nation in decades; and considering Brits are among the most indebted consumers in the world, consumption trends and defaults will feed the momentum of a localized financial crisis. In the meantime, the banking sector may have already pushed the United Kingdom into a crisis. This past week, the Bradford & Bingley was the second major British financial firm to be nationalized as a last resort bailout. If global rates don’t offer a better response to the accepted $300 billion US bailout plan passed Friday, further collapses are practically guaranteed. Policy officials and market participants will therefore closely monitor the level of Libor rates and watch for any news that BoE Governor King or PM Gordon Brown are considering a more permanent rescue of their own.

A natural extension of the same factors that have pushed the UK to the edge of its own financial crisis, speculation of a UK recession has spread quickly. In fact, the fears of a particularly bad recession and localized credit crisis are so bad that the consensus in the market and among economists is that the Bank of England will deliver a 25bp rate cut when the MPC meets on Thursday. This certainly comes at a heavy costs as inflation is still far above the central bank’s target rate and the Governor has to write a letter to the Chancellor of the Exchequer whenever the benchmark reading is above 3.0 percent. At this point, the probability of a rate cut is being priced into sterling exchange rates; though it may not be fully discounted. If policy makes follow through with the market’s forecasts, the pound will likely drop modestly; but it will be the statement that follows the announcement that really gets things moving. If the group leaves the door open for further cuts, that pound’s position as a liquid carry currency will be called into question.

Jamie Saettele is a Technical Currency Analyst for FXCM.