Fundamental Outlook for British Pound: Bearish

- Fundamentals collapse through a record trade deficit, a record low in home sales and 14 year low in December retail sales
- UK officials expanding their efforts to thaw credit markets by guaranteeing 21 billion pounds of corporate loans
- Risk trends showing a greater sway over the fundamentally week British pound

A year ago, the most risk-sensitive currency was probably the high-yielding Australian or New Zealand dollar as yields were the primary source of speculation for traders. However, this dynamic has changed as global interest rates have trended towards zero while liquidity and fundamental stability have become a valuable commodity. This has put the spotlight on the British pound which is backed by an economy that threatens to tumble into a deep recession and an interest rate that could very well be at zero within a few months time.

Looking out at the coming week, the UK docket promises to be the most active – thereby imparting the sterling with the greatest potential for fundamentally inspired price action. Among the many economic releases, the most market-moving is without question the advanced reading of fourth quarter GDP. Not only will this mark the severity of the United Kingdom’s burgeoning recession; but it will also stand as a benchmark for the global recession as the notable first G10, year-end growth number. Just this past week, central bankers from the world’s financial centers at the Bank of International Settlements (BIS) meeting agreed that the world economy was going to slow “significantly” in 2009. From this dour outlook, we will see a key currency market fundamental driver emerge. Which economy is experiencing the least severe contraction, looks to recover first and will have a natural rate advantage over their global counterparts are questions that will define major fundamental trends. The UK’s leading GDP number is expected to cross the wires with a 1.4 percent annualized slump – what would be the worst recession for the economy since 1991. At this rate, the pound looks to keep its title as the worst fundamental performer.

Event risk doesn’t rest with the growth figures alone. Though more mundane, many of the other economic indicators scheduled for release are top tier in their own right. Finding a common link in the data, it can all be linked back to consumers – the lynchpin of economic activity going forward. For the sector that started it all, the housing recession will take direction from the January Rightmove figures. Surprises will be limited here – whether it be a rebound or an extension in the otherwise well-established slump. Credit, employment and consumption trends are less certain. PM Brown and BoE Governor King have attempted to unfreeze credit, to no avail; which makes the public sector net borrowing figure an interesting reading. The December jobless claims change is expected to extend the worst labor trend since 1991 and retail sales are oddly enough expected to post only a modest monthly decline through the same period. For a broader reading, the December CPI numbers may lend credibility to the MPC’s concerns that deflation is a real threat for the economy; but its more immediate influence will be on the interest rate outlook. The BoE cut its benchmark another 50 basis points last earlier this month to 1.50 percent. If price pressures drop back to or below target, it will be one more obstacle removed to setting a zero interest rate policy.

Antonio Sousa is a Currency Analyst for FXCM.