Fundamental Outlook for British Pound: Bearish

- British pound tumbles to record low versus euro amidst diverging interest rate outlooks
- The BOE’s most dovish MPC member will step down in May 2009
- UK producer prices fall for fourth straight month, adding to speculation the BOE will continue cutting rates

The British pound climbed against the US dollar throughout last week, but the currency’s status versus the euro is a bit more indicative of the fundamental outlook for the UK economy. Indeed, the EUR/GBP pair hit a fresh record high of 0.8999 on December 12, and conditions in the Euro-zone are by no means strong, but they are comparatively better than in the UK as the credit crunch has choked off the finance sector that has previously allowed the country to thrive for so long. Furthermore, various European Central Bank members have suggested that monetary policy will not be made much more accommodative in coming months. In the UK, on the other hand, the Bank of England is anticipated to continue cutting rates aggressively, as BOE Governor Mervyn King has declined to rule out cutting rates to zero in the past.

Looking ahead to this coming week, economic data is likely to add to evidence suggesting that interest rates in the UK are bound to fall lower, but the minutes from the BOE’s December policy meeting will probably be the best gauge of this. During this meeting, the BOE’s Monetary Policy Committee slashed the Bank Rate by 100bps to 2.00 percent, as expected. The key will be to watch the vote count, as a unanimous decision to cut rates and indications that the MPC sees the need for additional rate cuts in the future could lead the British pound to pull back sharply.

That said, the other releases due out this week shouldn’t be ignored, as they have the potential to spark volatility in the British pound. On Sunday, Rightmove house prices have the potential to fall to yet another record low on a year-over-year basis, highlighting the extend of the UK’s housing sector collapse. On Tuesday, UK CPI is expected to fall negative for the second straight month and may bring the annual rate down to 3.9 percent from 4.5 percent. However, given the plunge in commodity prices in recent months along with waning domestic demand, there is a possibility that CPI could fall even more than expected. On Wednesday, UK jobless claims will hit the wires at the same time as the BOE meeting minutes, and they could exacerbate any bearish impact on the British pound from the minutes as claims are forecasted to rise for the tenth straight month and by the most since December 1992.

Jamie Saettele is a Technical Currency Analyst for FXCM.