Fundamental Outlook for British Pound: Bearish

- Pound Pushes To A Six Year Low Against Dollar After BoE’s King Says He Won’t Discount Bringing Rates To Zero
- European Central Banks Face Tumbling Inflation Rates And Recessions By Readying The Markets For Further Rate Cuts
- Read The DailyFX Monthly Forecast For GBPUSD For A Fundamental And Technical Outlook

While most of the currency market was consolidating this past week, the high volatility underlying the market led the fundamentally weak British pound to push new lows. And, considering the outlook for growth and interest rates, the immediate future looks bleak for this once high-flying currency. The first concern for traders as the economic winds pick up next week will be the outlook the interest rates. Up until a few weeks ago, one of the few things the sterling had going for it was the expectations that the global recession would be short-lived and the return of risk appetite to the market would find a relatively high benchmark lending rate in the UK. However, interest rate expectations have quickly turned from boon to burden for this European economy. After the Bank of England surprised the market with a massive 150 basis point rate cut two weeks ago, any hopes that the currency would benefit from a reversal in yield appetite quickly diminished. After BoE Governor Mervyn King acknowledged he would not rule out lowering interest rates to zero to restore order to the economy and markets, speculators recognized the full scope for policy easing going forward.

However, looking to Credit Suisse overnight index swaps, we can see that only 100 basis points of additional easing are priced in over the coming 12 months. This highlights a significant imbalance between what the market is projecting and how aggressive the MPC may actually be should conditions worsen with time. A fundamental divergence of this magnitude opens the pound to significant moves as these split expectations converge into one reality. The minutes scheduled for release on Wednesday will be instrumental in driving forecasts one way or the other. The vote will be of upmost importance. Lowering the benchmark lending rate as aggressively as the BoE did to a 53-year low could not have been made easily and debate over this move’s efficacy is expected. Noting the extreme: if all nine MPC members voted for the massive rate cut, it would clear the way for further, aggressive rate cuts going forward.

Aside from the vagaries of rate speculation, the economic calendar will give a more definite read on the factors that policy officials will consider when voting in future meetings. Inflation will take a play a key role in defining the scope for further cuts. Before the BoE was set its recent pace of loosening monetary policy, Governor King ironically quipped that he expected to write a number of letters to Chancellor of the Exchequer Darling explaining why inflation was so high and what would be do to tame it. While statements made by central bankers suggest they have moved on expectations of a collapse in price growth (their primary mandate for policy), they have yet to see confirmation of this yet. Should, CPI (the primary gauge for inflation) drop more sharply than expected in its October reading, it would open the door wide open to further gouges in the benchmark lending rate. The longer-term concern, however, will be in the eventual rebound in economic activity. A drop in the cost of living will help to offset the sharp decline in employment and wages expected for the coming months. And, the rest of the economic calendar will make sure to concentrate fears over growth. Housing, industrial trends, consumer spending and public borrowing readings promise nothing more provide additional confirmation that this evolving recession will be far worse than the slump of 1992.

David Rodriguez is a Currency Analyst at FXCM.