Fundamental Forecast for British Pound: Neutral

- U.K. GDP revised higher to 1.2% ffrom 1.1%, despite drop in business investment
- CBI reported retail sales in August unexpectedly expanded to 35 from 35, against forecatst for a drop to 18
- BBA loans for home purchase in July fell more than forecasted to 33,698 versus 34,000

The British pound slipped against most of the majors on the week but ended on a strong note as a return of risk appetite helped sterling erase earlier losses. Comments from Fed chairman Ben Bernanke that the central bank will do whatever it takes to promote growth in the world’s largest economy and a not as weak as expected revision to US 2Q GDP helped fuel risk appetite. An upward revision in the U.K. GDP reading provided a domestic argument for bullish sentiment. The news built upon the strong retail figures in August from the Confederation of British Industry which helped bring an end to previous decline. Weak home loan data raised a red flag that credit conditions remain too tight for the BoE to consider tightening despite inflation above their 3.0% threshold.

The BoE continues to maintain that inflation will ultimately return to their target level of 2.0% despite consumer price growth over shooting their earlier estimates. Policy makers pint toward temporary factors such as a rise in oil prices and an increase n the VAT as the cause for the unexpected high level of inflation in an economy that is just emerging from a recession. Martin Weale, the newest member of the Bank of England's interest rate setting committee, has warned that the UK faces a "significant" risk of plunging into a double-dip recession. The dovish outlook should more than offset the hawkish Andrew Sentance who has voted for a rate hike the past three policy meetings-as the majority of the MPC is in agreement. However, economists are starting to express concern that once the recovery takes root, soaring inflation could threaten longer-term growth. The calls for tightening are growing and if U.K. fundamentals continue to improve the central bank may be forced to begin tightening sooner than they want.

Forecasts for the manufacturing Purchasing Manager Index for August to decline to 57.0 from 57.3 will support the BoE’s dovish outlook and growth concerns. The sector has been the main driver of growth and if the pace of expansions slows for a third straight it may be a sign that the recovery could be in jeopardy. Mortgage approvals and consumer credit data could also present event risk as tight credit conditions is the central bank’s biggest concern. Ultimately, risk trends could remain the biggest driver of price action which could lead to a quiet week with the U.S. Non-farm payroll report looming on Friday.

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