Fundamental Forecast for British Pound: Neutral

The British Pound rallied to a fresh monthly high of 1.5888 on Friday, and the exchange rate may continue to push higher over the near-term as investors speculate the Bank of England to start normalizing monetary policy later this year. The economic docket for the following week is expected to show inflation expanding at the fastest pace since May, with market participants forecasting consumer prices to rise at an annualized pace of 3.4% in December, and the stickiness in price growth is likely to spark a bullish reaction in the sterling as the central bank drops its dovish outlook for future policy.

At the same time, retail spending in the U.K. is projected to weaken 0.3% during the same period, while jobless claims are expected to hold flat after slipping 1.2K in November, and the mixed batch of data could lead the GBP/USD to consolidate over the following week as investors eagerly wait for the BoE policy meeting minutes due out on January 26. As price pressures intensify, we are likely to see the MPC turn increasingly hawkish over the coming months, and the central bank may see scope to lift the benchmark interest rate off the record-low as it aims to balance the risk for the region. According to Credit Suisse overnight index swaps, investors expect the BoE to hike borrowing costs by at least 50bp this year, and the rise in interest rate expectations may gather pace over the coming months as the central bank struggles to contain the acceleration in price growth. However, we expect to see another three-way split within the committee as board member Adam Posen anticipates the ongoing weakness in the economy to bear down on price growth, and there could be a growing tear within the MPC as the fundamental outlook remains clouded with uncertainties.

As the recent rally in the GBP/USD tapers off ahead of the December high (1.5910), we may see a corrective retracement unfold next week, and the exchange rate may trend sideways over the coming days as the relative strength index holds below 70. However, another break to the upside should lead the pound-dollar to retrace the decline from back in November, and the British pound may outperform against its major counterparts next week as interest rate expectations increase.

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