Fundamental Forecast for British Pound: Neutral

- UK Manufacturing Slows, Service Sector Disappoints
- British Pound Consolidation Continues at Fib Support
- Speculative Sentiment Hints Pound Losses vs US Dollar

A forceful recovery in risk-taking promises gains for the British Pound as sentiment remains the dominant catalyst of price action, with GBPUSD showing a correlation reading of 0.64 with the MSCI World Stock Index on 20-day percent change studies. However, seasonal factors may complicate the risk landscape while monetary policy will vie for attention however as the Bank of England delivers an interest rate decision.

Risk appetite staged an impressive comeback as US economic data surprised sharply to the upside throughout last week, starting with a outperformance on the consumer confidence reading, followed by an unexpected pickup in manufacturing growth, and closing out with a much stronger than expected jobs report. Equity markets responded accordingly as traders continued to look to the health of the world’s largest consumer market as the bellwether for the global recovery at large, with the MSCI World Stock Index snapping three consecutive weeks of losses to add 3.7 percent, the most in two months. The docket of US event risk pales by comparison in the week ahead, seemingly suggesting that little stands in the way established pro-risk momentum and promising continued gains for stocks and related currencies.

That said, the week ahead marks an important seasonal turning point – the US Labor Day holiday – which typically serves as the line in the sand between the “summer doldrums” period when most traders are on vacation (usually marked off starting with the US Memorial Day holiday at the end of May) and the time when they return to the markets. Equity markets crept higher to add 4.8 percent between the Memorial and Labor Day holidays this year, thoroughly outdoing the historical average of less than 1 percent over the same period, but trading volumes plunged by a hefty 31.4 percent. This seems to undermine the conviction behind recent gains, hinting at the possibility that last week’s outperformance may have been the last gasp of a move soon to be reversed as investors put the summer behind them.

An interest rate decision from the Bank of England highlights the domestic economic calendar, but the outcome may not prove market-moving with policymakers unlikely to offer anything that has not been priced in for some time already. Expectations call for both key elements of monetary policy – benchmark borrowing costs and the QE asset purchase target – to remain unchanged at 0.5 percent and £200 billion, respectively. The central bank has argued for some time that the upswing in prices since the beginning of 2010 owes to temporary factors, with the annualizedinflation set to fall back below 2 percent by 2012.Given such a prolonged time frame, Mervyn King and company are surely going nowhere fast despite a promise to shift policy “in either direction” as needed, a likely nod toward the threat of headwinds from the government’s austerity program. Indeed, a Credit Suisse gauge of priced in rate hike expectations hints traders are betting on no changes in benchmark borrowing costs at least until the second half of 2011, a view in place since early August.

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