Fundamental Outlook for British Pound: Bearish

- UK Consumer Confidence Tops Forecasts But Outlook Remains Bleak
- Bank of England Expands Asset Purchase Program, Holds Rates at 0.5%

The British Pound may see its recent gains challenged in the week ahead as a big dollop of negative economic data crosses the wires to weigh on the exchange rate. Judging by recent experience, Wednesday’s jobs report is likely to spark particular volatility: the sterling took a beating on the release of March unemployment figures despite a smaller-than-expected rise in Jobless Claims as the jobless rate surged to the highest level in over a decade. This time around claims are expected to add 82.5k, greater than the previous month’s 73.7k, to pushing the unemployment rate to 4.7%, the highest since January 2008. Persistent deterioration in labor conditions will undermine fiscal and monetary efforts to reboot economic growth, weighing on consumption and thereby total output by trimming disposable incomes among the unemployed and encouraging precautionary saving among those still working. The fallout in the industrial sector, which employs close to 20% of the UK labor force, is likely to keep a lid on a robust recovery in hiring for the time being as lackluster overseas sales of British manufactured goods has companies stick to lower output levels. Indeed, Industrial Production is expected to post another record-setting decline, shedding -12.8% in the year to March. Although the Trade Balance deficit is set to narrow to -7.2 billion pounds, the result is likely to owe more to a decline in imports rather than strong cross-border demand. Even after excluding oil shipments to factor out the fantastic collapse in crude prices over the past year, exports have trended sharply lower since July 2008 and snapped a multi-year uptrend dating back to the beginning of 2004 in January. To that effect, the improvement in the headline external balance figure speaks of the timid consumer, not an improving trade environment.

Broader measures of total output are likely to reflect the weakness in the underlying economic environment. April’s three-month gross output estimate form NIESR, a highly reputable think tank, is likely issue projections of another hefty loss. The outfit has previously asserted that the current downturn looks “very similar to that of the recession that began in the summer of 1979, [suggesting] output would continue to decline for up to another year and it would take two further years before the level of output enjoyed at the start of 2008 would be reached again.” Meanwhile, the Bank of England’s Quarterly Inflation Report seems sure to reflect an outlook that encouraged policymakers expand credit easing measures with downward revisions to GDP and inflation estimates.

Adding to the downside threat, the Pound seems to be losing its ties with risky assets: a 30-day rolling correlation study estimates that the link between the sterling’s average trade-weighted value and the MSCI World Stock Index has dropped to just 73% having stood at 84.8% as recently as two weeks ago. Looking at the longer-term trajectory of the relationship, a 180-day rolling correlation reveals that the link between the Pound and risky assets has been gradually easing since late December of last year. Weakening support from booming equities makes the British unit far more susceptible to succumbing to selling pressure as growth and interest rate expectations return as the driving force behind exchange rates.

Antonio Sousa is a Currency Analyst for FXCM.