Fundamental Forecast for British Pound: Neutral

- British consumers make the biggest repayment on credit on record
- European finance ministers call for global regulation to limit the size of banks, compensation
- Three months of congestion is excessive for a volatile pair like GBPUSD

How is it that the developed economy with the worst fundamental prospects touts a currency that is among the best performers for the year? Risk appetite. It is true that the currency market - indeed all markets - are highly efficient at pricing in new economic, political, exogenous data and events. However, when speculation is added to the mix, the otherwise clear view is muddled beyond recognition. For the sterling, the disparity seems particularly prominent. Over the past few weeks, data has confirmed a deepening recession, policy groups have projected a significant lag in its recovery relative to its peers and ballooning asset purchases by the central bank means rate hikes are the furthest thing from their mind. Yet, despite all of this, the pound could still break above 1.66 (1.70?) against the dollar, push the EURGBP exchange rate below 0.87 once again and even climb back towards a nine-month highs of 163 against the Japanese yen should risk appetite continue its march higher.

The strain is starting to show; but investor sentiment has maintained its northward march in spite of data, commentary and shaky sources of liquidity. At this point, though, the trend is in need of a revival. GBPUSD (a currency pair whose current rate is heavily reflective of the influence speculation can have), has been consigned to a 600-point range for an almost consistent three months. That is unusual for a pair this volatile. To put the pound’s trend back on path, a catalyst that can shake off the growing concern about a ‘U’-shaped recovery (or even a double dip recession) is necessary. However, with major central banks all turning to a ‘wait-and-see’ approach, discussions of exit strategies from stimulus when the UK has barely reported improvement and credit is still not making it to consumers and small businesses; it would seem that only the markets themselves can bear the burden. Standing outside the sphere of deteriorating British fundamentals, a rally in stock, commodities and other risk-related assets can encourage capital to the relative high returns in the UK (they have to be to encourage investment). The most bullish case for the currency would be a rally in risk appetite that spurs all the markets in tandem.

It is important to keep things in perspective though. While we can find the fuel for a pound rally through capital flows elsewhere, the fundamental health of the economy will act as a constant drag; and even the advance of risk appetite itself is starting to fade. Economic data due over the coming week could not only add fundamental weight to the pound; but it could also warp the currency’s vital relationship to risk appetite. Among the many economic releases, we will cover the gamut of total economic health. For the consumer, the BRC retail sales monitor and Nationwide consumer confidence survey will measure willingness to spend (their contribution to overall growth). Visible trade, industrial production and factor-level inflation will take the temperature from the business level. Even the NIESR GDP estimate will hold a little more influence with the focus so intense on a recovery.

All the data aside, the most influential piece of event risk through the week is the BoE policy announcement. Neither economists nor the market is predicting any change to the benchmark rate; but once again, it is their forecasts for when interest rates will change that is important for speculators. It is important to take note of the asset purchasing programme which was recently lifted well beyond what its cap was initially set out for. There is very little chance that they will alter the size of this program, but clues in regards their next move and timing will be could be very market moving. The more uncertainly factors are forecasts for growth, inflation, financial health. Changes to these bearings will no doubt adjust the bearing on when the MPC can once again entertain the thought of a rate hike.

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