Fundamental Forecast for British Pound: Neutral

- Retail Spending Contracts in November
- U.K. Labor Conditions Unexpectedly Improve
- Public Sector Borrowing Rises at Record Pace
- U.K. Consumer Prices Top Forecast

The British Pound broke out of its narrow range and slipped to a fresh monthly low of 1.6053 this week following an unexpected drop in U.K. retail sales, and the GBP/USD is likely to face increased volatility as the final 3Q GDP report and the minutes of the Bank of England policy meeting are scheduled for release over the following week. Meanwhile, the central bank held a cautious outlook during its semi-annual Financial Stability report and said the “probability of default by U.K. real estate companies have increased significantly,” and said smaller firms will face “significant” challenges going forward as the central bank anticipates loan-related losses to intensify over the following.

At the same time, the central bank said the withdrawal of government support may fuel volatility in asset-prices, which could also trigger an unwinding in dollar trades, and noted that “banks remain exposed to any further deterioration in macroeconomic and market conditions, which could substantially raise the cost of funding and capital rising.” Nevertheless, a separate report by the BoE showed inflation expectations for the following year were firmly anchored at 2.4% in November, which should allow the central bank to maintain its current policy going into 2010, and the minutes of the December policy meeting are likely to highlight a dovish outlook for future policy as the MPC continues to see a risk for a protracted recovery.

On the other hand, the final 3Q GDP reading is expected to show a 0.1% contract amid an initial forecast for a 0.3% drop in the growth rate, and the data is likely to encourage an improved outlook for the region as policy makers see the economy emerging from the worst recession since the post-war period. Furthermore, the British Bankers Association’s gauge for home mortgage approvals is forecasted to increase to 43K in November from 42.2K in the previous month, which would be the highest reading since November 2007 however, the ongoing slump in service-based activity may continue to weigh on the outlook for future growth as it accounts for more than two-thirds of the real economy. As market liquidity thins ahead of the holiday season, we are likely to see increased volatility paired with erratic price action as investors worldwide go off-line in observance of the Christmas holiday but nevertheless, as risk trends continue to drive the FX market, a rise in risk appetite could push the exchange rate higher as the U.S. dollar remains the most popular funding-currency, next to the Japanese Yen.

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