Fundamental Forecast for British Pound: Bearish

The British pound is firmly anchored to underlying trends in risk sentiment, with the correlation between GBPUSD and the MSCI World Stock index finishing last week at the highest in four months on 20-day percent change studies. The economic calendar promises to reinforce the relationship: CPI figures are expected to show the annual pace of inflation held above 3 percent for the eleventh consecutive month in November; meanwhile, jobless claims are forecast to improve for the third month. On balance, these outcomes point to a Bank of England that is likely to remain in neutral after delivering another non-event rate decision last week until either the price level retreats or the recovery is acutely threatened by the government’s austerity plan. As such, with the outlook on monetary policy firmly static, risk sentiment stands as the only major catalyst left for sterling to look to for its directional bias.

Sizing up sentiment, the major themes in play over recent weeks continue to point toward risk aversion as the path of least resistance. Sovereign stress in the Euro Zone remains significant, with periphery credit-default swap (CDS) spreads rising once again to erase month-to-date losses seen amid optimism in the wake of Irish bailout news. Chinese CPI figures showed inflation topped 5 percent for the first time in two and half years in November, hinting authorities will need to raise rates in earnest rather than incrementally increase reserve ratios, a policy that has proven largely ineffective. Finally, the proximity of the calendar year-end is likely to encourage profit-taking as traders continue to unwind risky asset bets linked to expectations of renewed Fed QE, a process that began in early November after Ben Bernanke and company delivered an asset-buying program in line with what investors had priced in over the preceding three months, robbing the risk rally that had developed over that period of the impetus to carry on.

All told, this points the way lower for the UK currency as it follows the broad-based selloff in risky assets. It is worth noting however, that a risk-averse scenario bodes ill for sterling when it is paired against its lower yielding and clearly safety-linked counterparts: the US Dollar and the Japanese yen. The tables turn when the pound is taken against the higher yielders, hinting that broad selling across the risk space is likely to see gains in pairs like GBPAUD and GBPNZD.

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