Fundamental Forecast for British Pound: Bullish

The British pound rallied for the second consecutive week against the U.S. dollar on the back of weakness in the world’s largest economy and continued growth in the U.K. This week will be critical for the British pound as concerns of elevated consumer prices linger. Thus, the Bank of England’s quarterly inflation report on Wednesday will provide some light for GBP traders ahead of the highly anticipated Bank of England minutes, which will be released the week following.

The spotlight will shift from the FOMC rate decision to the quarterly inflation report which is expected to take into account the massive spending cuts of approximately 800 billion pounds announced by the government approximately two weeks ago in order to battle its high budget debt. Last quarter, policy makers said that growth remained weighted to the downside, and went onto note that consumer prices were above the central bank’s 2 percent target due to temporary factors from oil prices and the value added tax (VAT) measures. It is also worth noting that the BoE said that the forthcoming increase in the standard rate of VAT to 20.0 percent from its current level of 17.5 percent will add to inflation throughout 2011. Similar concerns of the VAT will likely be highlighted on Wednesday, but whether the central bank changes its tone with regards to growth will be one of the main focuses amongst market participants. Indeed, economic activity topped economists’ expectations in the third quarter, while Bloomberg News reported that the S&P credit rating agency said the U.K. does not face the risk of a downgrade as pressure eases on the Bank of England to add further stimulus measures. It seems that the Bank of England also feel as if they can weather the storm in the near term as policy makers refrained from adding onto their asset purchases last week. All in all, the quarterly inflation may provide clues ahead of the Bank of England Minutes. Not to overlook, industrial and manufacturing production, and the NIESR GDP estimate are all on tap.

Strength in the British pound cannot solely be attributed to growth in the U.K. The Fed recently announced new asset purchases of 600 billion dollars in order to stimulate growth as the economy continues to face major hurdles. As a result, the greenback has come under pressure against most major currencies. Meanwhile, the employment rate is at 9.6 percent, and will likely push higher, while households face slow wage growth and tight credit conditions. Despite the upbeat Nonfarm payrolls report, it is worth noting that America will need to add 232,400 jobs a month to return to the pre-depression labor force levels (which is very unlikely). Thus, the question that now arises in the global markets is if the recent actions by the Fed will boost growth, or will there be QE3 announced in the future. Many analysts and economists expect the latter, and countries are concerned that impact of the Fed’s action will undermine their own economies. However,during the short term, the U.S. dollar looks poised to continue its southern journey against most major currencies.

Taking a look a look at the GBPUSD, the pair has halted its three day decline; however downside risks are capped by 1.600. Going forward, I will look to buy any dips as my bias remains to the upside. The MACD continues to point to further advancements in the pair, while the parabolic SAR has yet to reverse course. At the same time, our speculative sentiment index stands at -1.26, and signals for additional gains.

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