Fundamental Forecast for British Pound: Neutral

- U.K. jobless claims fell 20.8k in June, lowering the claimant count rate to 4.5%
- Inflation slowed to 3.1% from 3.4%, but above 3.0% for fifth month
- The final U.K. GDP reading for 1Q was unchanged at 0.3%

The British Pound resumed its bullish trend after ending lower the week prior with the GBP/USD closing higher for the fifth time in the past six weeks. However, a broad based flight to safety saw the British unit fall sharply to end the week taking the luster off of the recent progress. The main catalyst for sterling support has been solid U.K. fundamentals and signs that the European debt crisis won’t reach British shores. Expectations for more positive fundamental signs and the results for the European bank stress test could see the same themes dictate direction unless broader pessimism prevails leading to an extension of Friday’s bearish decline.

The U.K. economy continues to show signs of being able to sustain growth in the face of the austerity measures being under taken by the new government. Jobless claims declined by 20,800 in June as the claimant count rate fell for a fifth straight month to a one year low. The improving labor market and declining inflation raised the outlook for domestic growth. Indeed, consumer prices decelerated from 3.4% to 3.1% but remained above the central bank’s threshold for a fifth month. Although, inflation trending lower takes pressure off of policy makers to raise rates which would typically be bearish for the pound, declining from such dangerous is a positive for the long-term health of the economy.

BoE member David Miles looked to dampen the outlook for a rate hike stating that "I look forward to the day when it will be appropriate to tighten monetary policy since a return to more normal levels of interest rates would be a welcome sign that economic conditions were also more normal. But I do not think that is where we are today." However, some MPC members have expressed concern over inflation including Andrew Sentence which increases the potential that the minutes from the last policy meeting could show a break in ranks with votes for tightening. The prospect of a rate hike could reignite sterling support especially if we see the fundamental calendar add to the case.

The upcoming economic calendar is full of event risk for the pound starting with the Public sector net borrowing report which is expected to show the deficit in June was 13 billion compared to May’s 16 billion. A shrinking deficit may raise the outlook for a rate hike with inflation above the central bank’s 3.0% threshold. The June retail sales report and the reading for second quarter GDP are forecasted to show sustained domestic demand and growth which would continue the theme of strong U.K. fundamentals and could restore bullish sterling sentiment. However, corporate earnings can’t be discounted and their potential impact on broader sentiment may have a greater impact on short-term price action.

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