Fundamental Forecast for British Pound: Bearish

The British pound pushed higher against the greenback this week, but the advance may be short-lived as the outlook for Great Britain points to losses. Market participants will shift their focus to the Bank of England interest rate decision and asset purchase target. As the central bank will likely remain on hold, debt contagion fears in the Euro-zone and tension amongst South and North Korea may dictate price action as traders will likely seek safety in the case of further negative developments in either region.

Ahead of the BoE rate decision, traders are pricing in a 1 percent chance that the central bank will raise rates twenty five basis points on Thursday, according to the credit Suisse overnight index swaps. Policy makers in the region are at the crossroads as inflation remains at elevated levels and are expected to continue their course heading into 2011 as the rise in the value added tax measures will put upward pressure on prices, backing Andrew Sentence’s call for a rate hike. This does not bode well for U.K. policy as the region had the third largest fiscal deficit in the EU last year, while the upcoming spending cuts will likely weigh on growth in the coming months. Therefore, I expect the central bank to keep a lid on both interest rates and asset purchases until next year as the committee gauges the impacts of the austerity measures next year. Not to overlook, industrial and manufacturing production, in addition to producer prices are on tap. Though the economic docket in the U.K. is filled with a slew of events, traders should not overlook concerns outside of the economy, which may overshadow domestic developments and dictate GBP price action.

This past week, the British pound was weighed by risk aversion as traders sought safety as debt contagion fears in the 16 member euro area resurfaced on the back of Ireland’s woes. The concerns put downward pressure on markets in the U.K. due to the fact that banks in the region have a larger exposure to the Irish financial system than any other country. In turn, the yield on Irish bonds went sky rocketing, global stocks plummeted, and Ireland was forced to accept the life line of 85 billion Euros ($113 billion) in order to withstand the headwinds of the banking crisis. Adding onto market mayhem, North Korea shelled South Korea, killing at least 2 people, marking the most dramatic confrontation since the Korean. In turn, the U.S. dollar rallied against most of its major counterparts amid safe have flows. As of late, a top South Korean presidential security advisor said Seoul is prepared to bomb North Korea if Pyongynag again hits the South with artillery. Thus, it will be important to monitor not only the fundamental developments in the U.K., but also investor sentiment on the back of global concerns.

Taking a look at price action, the overall trend in the GBPUSD is to the downside as price action recently broken below the rising channel that remained intact for five months. Indeed, there is major resistance at the 1.5850 level and so long as price action is capped by this level, downside risks remain. At the same time, the MACD has yet to reverse course after signaling for losses in the middle of November, while our speculative sentiment index 1.30, also pointing to declines.

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