Fundamental Outlook for British Pound: Bearish

- Consumer Prices Fall to Lowest in 15 Months in April
- GDP Data Confirms Economy Shrank At Record Pace in First Quarter
- S&P Downgrades UK Outlook to ‘Negative’ on Growing Budget Deficit

The British Pound could continue to rise next week as an uneventful economic calendar offers little event risk to slow the currency’s momentum. Last week, the sterling showed surprising resilience in the face of a record drop in gross domestic product, a weak CPI report , and news that rating agency S&P downgraded their UK outlook from “stable” to “negative”. It seems traders heard everything they needed to about the economy’s prospects a week earlier when the Bank of England’s quarterly inflation report revealed expectations inflation will remain below the target 2% until 2012 as the economy takes a slower path to recovery, taking the punch out of subsequent releases along the same theme. The lack of potency in negative economic data suggests that the Pound remains at levels that are too low to attract new sellers all the while those that are already short become increasingly anxious about overextending their exposure, quickly rushing to cover their positions at the slightest hint of a reversal. Put simply, the British Pound seems heavily oversold and likely needs to correct still higher before it becomes attractive to sell once again.

Little stands in the way of the Pound’s momentum in the week ahead: Nationwide House Prices are set to drop -1% in May to bring the annual pace of decline to -13.7%, a reading well within the range of values that has been seen since the free-fall in property values moderated towards the end of 2008; GfK Consumer Confidence is seen rising to -25 in May from -27 in the preceding month, the seventh consecutive time that the rate of contraction in sentiment has slowed (likely owing to the government’s stimulus measures). While neither release speaks of a robust economy (albeit they do hint at one that is shrinking at a slowing rate), the trends behind these indicators have long been priced in and are unlikely to make or break the current bullish upswing in a meaningful way.

Turning to risk sentiment, short-term studies reveal a declining link between the MSCI World Stock Index and the trade-weighted average value of the British Pound. Indeed, 30-day correlation studies reveal the link now stands at 56% having printed as high as 86% as recently as late April. This suggests that the currency may not suffer a setback even if risky assets confirm a double top at resistance marked by the high from early January’s, a scenario that could well materialize in the near term.

Jamie Saettele is a Technical Currency Analyst for FXCM.