Fundamental Outlook for British Pound: Bullish

- The Bank of England cuts its benchmark another 50 basis points and adds commentary that sparks speculation of a hold
- Service and manufacturing sector contractions ease, but still far from expansionary levels
- Confidence in credit conditions deteriorate after Barclays’ debt rating is lowered

The British pound exhibited extraordinary strength this past week; and GBP/USD was even able to break through significant resistance in a trendline that can be traced all the way back to October. This is a substantial shift for the battered sterling; but fundamentals will need to feed a sustainable rally or the currency may face a collapse that could spur the needed momentum to finally pulls the pound through to new lows. And, looking at the frail sentiment that is currently driving the currency as well as the dour outlook for scheduled economic event risk, the odds are stacked against the beleaguered currency.

Looking ahead to fundamental trends heading into the new week; we first need to gauge the catalyst for this tentative, bullish breakout for the pound. There were some modest improvements in economic data; but overall, the indicators were just off their respective recent record lows. The real driver is a combination of a possible rebound in risk appetite and speculation that the Monetary Policy Committee (MPC) will curb its appetite for further rate cuts. Through the past 18 months, the British currency has been one of the hardest hit currencies as speculative and carry flows have been unwound. Pushing levels that even a bear would admit were probably oversold, it makes sense that the sterling would be one of the first to recover in a general improvement in sentiment. However, such a significant shift contradicts the negative trend in growth and yields; so caution will be an indelible aspect of this rebound. The weaker driver behind the pound’s advance is found in speculation that the central bank is ready to take a neutral stance on interest rates and thereby prevent the benchmark from reaching zero – a point at which the market truly recognizes the policy authority is running out of options (like the BoJ for the past decade). This bold assertion seems to be based on the comment that “past cuts…would in due course …have a significant impact.” These are certainly ambiguous comments that do not provide for a halt to rate hikes in any certain terms. As confirmation, traders will look for commentary from policy member, to the institution of their commercial asset purchasing facility scheduled to begin on Friday and Wednesday’s quarterly policy report.

Officially, the BoE’s broad assessment is called the Quarterly Inflation Report; but realistically it covers growth and financial market activity as much as it does price pressures. For the economy that the IMF expect to be suffer the worst recession among the major industrialized nation, growth and market health are far more essential that inflation at this point. Considering the statement that accompanied this past week’s rate decision, we would expect cautious optimism buffered heavily by the disappointing data that has crossed the wires recently. Language that suggests Europe’s second largest economy is set to rebound much more quickly and sharply than speculators and economist are expecting would go a long way towards restoring confidence – especially if this comes in conjunction with a general rebound in confidence. Aside from this lagging wrap up on the economy, we will also see a set of notable but more mundane market-movers. BRC retail sales and the RICS house price balance will gauge consumer sentiment; but it will be the labor data that truly benchmark optimism. Also, the visible trade numbers will measure not only the outflow of capital from the UK but also the global level of demand as a gauge of growth.

John Kicklighter a Currency Strategist at FXCM.