Fundamental Forecast for British Pound: Bullish

- UK budget woes send British Pound lower
- British Pound nonetheless outperforms and receives bullish SSI forecast
- UK Gross Domestic Product data likely to move markets in week ahead

The British Pound survived a week of sharp US Dollar and Japanese Yen, outperforming major rivals despite mixed economic data. An early-week upward surprise in December Consumer Price Index numbers likely helped, moving forward timetables for Bank of England interest rate hikes. Indeed, year-over-year CPI inflation rates unexpectedly reached 2.9 percent; at rates above 3.0 percent, the governor of the Bank of England must write a letter to the Chancellor of the Exchequer to explain why prices have gained so rapidly. Formalities aside, buoyant inflation rates present a fairly important challenge to the BoE and Overnight Index Swaps jumped in expectations of higher interest rates. Late-week Retail Sales data brought said OIS forecasts back to pre-CPI levels, however, and it will be critical to watch data in the week ahead to gauge likely direction in UK interest rates and the domestic currency.

All eyes will be on be on Tuesday’s UK Fourth Quarter Gross Domestic Product growth rate numbers—one of the first such Q4 GDP reports out of the world’s largest economies. Consensus forecasts call for the first quarter-on-quarter UK economic expansion since the onset of the “Great Recession”. Such lofty expectations could clearly make for sharp price volatility on especially noteworthy disappointments, and the British Pound’s recent outperformance will almost certainly be put to the test.

It is especially interesting to note that the GBP has proven somewhat immune to the recent sharp deterioration in financial market risk sentiment. The previously high-yielding currency has historically been susceptible to sharp depreciation through times of financial market duress. The Pound nonetheless held strong despite the worst 2-day performance in the S&P 500 since early 2009 tumbles. Said feat is especially impressive given that the US Dollar remains a top target of safe-haven market flows, and relative stability in the GBP/USD bodes well for short-to-medium-term trends.

Forex futures and options data confirms that trader sentiment on the British Pound is far from dire, and we expect the GBP to outperform the EUR, AUD, NZD, and CAD if there are continued periods of financial market turmoil. Given aggressive S&P 500 declines, we see risk of a much larger correction in financial market risk sentiment.

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