Fundamental Forecast for British Pound: Neutral

The British pound pared the advance from earlier this month as economic activity in the U.K. unexpectedly weakened in the fourth-quarter, and the sterling may face additional headwinds over the following week as the outlook for future growth deteriorates. The U.K. economy contracted 0.5% during the last three-months to mark the biggest decline since 2009, and fears of a double-dip recession could intensify as private sector activity remains subdued.

The economic docket for the following week is expected to show mortgage approvals increasing 46.5K in December following the 48.0K expansion in the previous month, while the gauge for manufacturing is expected to fall back to 58.0 in January from 58.3 in the month prior. As the rebound in economic activity tapers off, the slew of event risks could spark a selloff in the exchange rate and lead the GBP/USD to retrace the rally from the monthly low (1.5405) as investors weigh the prospects for a sustainable recovery in Britain. In turn, the Bank of England may continue talk down the risk for inflation as it expects the ongoing slack within the real economy to bear down on price growth, and the central bank may adopt a dovish tone for future policy as the fundamental outlook remains clouded with high uncertainty.

Nevertheless, the BoE policy meeting minutes release earlier this week showed a 6-2-1 vote count as Andrew Sentance and Martin Weale saw scope to start gradually normalizing monetary policy, while board member Adam Posen pushed to expand quantitative easing by another GBP 50B in order to encourage a sustainable recovery. As the central bank struggles to balance the risk for growth and inflation, there is likely to be growing split within the MPC, and the dissenting views among the committee could translate into further British Pound weakness as interest rate expectations falter. However, as BoE Governor Mervyn King expects inflation to accelerate over the coming months, there could be increased pressures on the central bank to dampen the rise in price growth, and a growing number of the MPC may heed to Mr. Sentance’s call as consumer inflation expectations heighten. Accordingly, hawkish comments coming out of the BoE could prop the exchange rate going into February, but any advances in the British Pound could be short-lived as the economic outlook weakens.

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