Fundamental Forecast for British Pound: Bearish

- UK industrial production was stronger than expected, showing the first back-to-back increase since September 2006
- The nation’s trade deficit narrowed in August thanks to a 5 percent rise in exports
- The British pound rallied after the Bank of England left rates, QE stance unchanged

The ascent of the British pound against the US dollar over the past week suggests that the currency has experienced broad strength, but this certainly was not the case. In fact, the British pound fell roughly 1.3 percent against the New Zealand dollar, dropped 0.9 percent against the Japanese yen, and slipped a slight 0.3 percent against the euro. Furthermore, the British pound was second only to the greenback in being the weakest of the majors over the past month, with GBPJPY having plunged almost 5 percent. Overall, despite recent improvements in economic data, the combination of the Bank of England’s liberal quantitative easing stance and bleak outlooks regarding the fiscal health of the nation creates significant bearish pressures for the British pound. That said, this isn’t incredibly apparently in GBPUSD, but is more easily seen in pairs like GBPJPY and EURGBP. This could change in the coming week though, as GBPUSD ran into falling trendline resistance drawn from the July 2008 highs at 1.6735.

Looking ahead to next week’s event risk, the UK’s consumer price index (CPI) reading for the month of August is expected to rise 0.3 percent, but the more important part of this report is that the annual rate of growth, which is more closely watched by the Bank of England, is forecasted to fall to 1.4 percent, the lowest since October 2004, from 1.8 percent, keeping inflation within the central bank’s acceptable range of 1 percent - 3 percent, but below their 2 percent target. If CPI falls more than projected, the British pound could pull back sharply as the markets will anticipate that the BOE will expand their quantitative easing efforts even further before year-end. On the other hand, if CPI holds strong – which seems possibly in light of the rise in both input and output produce prices - the currency could rally in response.

Other notable releases include UK jobless claims, which are projected to have risen for the 18th straight month in August, this time by 25,000. Adding to this potentially disappointing result, the ILO unemployment rate could rise to 8.0 percent, the highest since November 1996, from 7.8 percent, which would not bode particularly well for the consumption outlook. This point may be highlighted by the UK retail sales report, which is only forecasted to rise by 0.1 percent. This indicator only tends to be market-moving upon large surprises, though, and a reading in line with expectations shouldn’t shake up trade too much. Finally, public sector net borrowing is expected to rise by another 17.6 billion pounds, which will only add to evidence that the nation’s fiscal health is rapidly deteriorating and suggesting that risks are growing for a downgrade to the UK’s AAA credit rating.

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