Fundamental Forecast for British Pound: Neutral

- BoE left their benchmark rate unchanged at 0.50%, while pausing the asset purchase program at £200 billion.
- Manufacturing PMI unexpectedly rose in January to 56.7 from 54.6
- U.K. construction industry improves, as service sector weakens

The British pound tumbled to end the past week against the dollar and yen led by broad based risk aversion sparked by the budget issues in Europe. Stocks in Spain and Portugal nose dived as investors dumped assets from the countries as concerns grew that their budget deficits were unmanageable. Soaring yields sparked broader selling and traders looking for safety in the dollar and yen. The GBP/USD and GBP/JPY saw breaks below major support levels. Sterling/dollar dropped below Fibonacci support at 1.5742 before ultimately trading below 1.5600 for the first time since May 21, 2009. The global trend over shadowed the BoE rate decision where policy makers chose to leave the benchmark interest rate at 0.50% and paused the asset purchase program at £200 billion. This was in-line with expectations but a decline in December mortgage approvals had raised some speculation that additional QE was forthcoming. Therefore, following the release we saw a brief spike in cable support before giving way to the bearish trend.

Policy makers chose to leave the door open for quantitative easing as the U.K. economy barely ended its recession in the fourth quarter with 0.1% growth. The MPC expects efforts to date will “impart stimulus for sometime” and sees a lower sterling and recovering export markets as other drivers of growth. A gradual recovery is expected which has eased concerns over inflation currently threatening the bank’s threshold of 3.0% which would require Governor King to write a letter of explanation. The central bank expects consumer prices to fall below their 2% target for a period, but potential remains for further appreciation in the short-term. The threat of inflation had some market participants looking for the BoE to bring an official end to their asset purchase program which would have been the first step toward tightening.

Friday saw sterling losses outpace other bearish trending currencies which may be attributed to a sharp decline in U.K. interest rate expectations. Credit Suisse overnight swaps went from pricing in 60.7 bps to 44.87 bps of rate hikes over the next twelve months on Friday alone. The sharp decline is an indication that despite rising inflation the central bank is expected to remain on hold which could limit potential for future growth. The upcoming BoE quarterly inflation report will go a long way toward determining yield outlook and is the major event risk for the week. The Visible trade balance and industrial production also dot the calendar and will give insight into whether the demand for exports is continuing to drive growth as expected.

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