Fundamental Forecast for British Pound: Bearish

- Some officials are calling for an imminent recovery for the UK, others a looming collapse
- Mortgage approvals hit an 18-month high, pointing to the recovery of a vital economic sector
- Congestion is well established for GBPUSD, but a definitive dollar rally can trend chop into a H&S reversal

Many of the dollar-based majors are on the verge of a major trend reversal in the greenback’s favor. However, while GBPUSD saw a sharp decline in response to this past Friday’s volatility and broad dollar bid; the pair is far from the brink of its own defining reversal. The fundamentals behind the British pound are very different than those of a stable euro, safe haven dollar or yield-bearing Aussie dollar. This single currency may be weighed by a discouraging growth and interest rate outlook; but it may also be fundamentally oversold. Just as the sterling hit a point of overbought just before the financial crisis spread and tagged the other end of the spectrum when investors were fully invested in safe havens; the time will come when the dire outlook will prove overindulgent. That time may come sooner than many think.

The general weakness in the British pound is understandable. Not only has the economy struggled to ensure an exit from its recession and monetary policy slackened to the point where further expansion will do little good; but speculators have been consistently burned by trying to call an early turning point. The disappointment began in late October when speculation that the Bank of England would soon start reining in its stimulus was immediately cut off by the unexpected contraction of 3Q GDP. Policy officials admitted this outcome was unexpected; and in the subsequent policy meeting on October 5th the MPC voted to increase its bond purchasing program. However, in this event there would be a modest but positive surprise in that the group actually increased the quantitative easing program by a smaller than expected 25 billion pounds to 200 billion. Now, heading into the next policy decision this Thursday; we can see that the debate for expanding versus contracting policy has grown increasingly heated. Last week, BoE Chief Economist Spencer Dale remarked that the economy had likely already turned the corner and short-term inflation would likely rise above the bank’s 3 percent threshold. In contrast, lawmaker Mark Field faces a possible currency crisis and the loss of its top sovereign credit rating should parliament come out of the upcoming election with a split house. Who is right? Only time will tell. However, where the central bank leads the market; traders will follow. No change is expected in the benchmark lending rate or the bond purchases; but even holding steady would make a statement following last month’s alterations. What’s more, the statement that accompanies the announcement will no doubt make an effort at transparency which is typically lacking from this often-volatile policy group.

Aside from the central bank decision, there are many notable fixtures on the economic docket. Following along the topic monetary policy; Chancellor of the Exchequer Alastair Darling will deliver the pre-budget report on the day prior to the central bank announcement. According to officials at the Treasury, Darling will trim his forecast for the cost in bailing out nation’s banks from 50 billion pounds to 10 billion. This is sizable deduction and would be a significant step in naturally reducing the liabilities in stimulus without any action from the government. For a bearing on growth, the NEISR GDP Estimate for November will prove important to supporting fragile expectations of a recovery after the previous month’s reading 0.4 percent contraction delayed hope of a recovery. For vital components to expansion, consumer spending will be measured through Nationwide Consumer Confidence and the BRC Retail Sales Monitor figures for November. The health of the business sector will also come into focus with the government’s factory activity report for October and the CBI Industrial Trends Orders for December. One of the few real consistent improvements though is coming out of trade which will be measured Wednesday. Finally, factory-level inflation data will tell us just how serious price growth is to policy.

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