Fundamental Forecast for British Pound: Neutral

The British pound made another run at 1.6400 as the economic recovery in the U.K. continued to gather pace, and the near-term rally in the GBP/USD may accelerate over the following week as investors speculate the Bank of England to gradually normalize monetary policy over the coming months. The BoE is widely expected to hold the benchmark interest rate at 0.50% while maintaining the asset purchase target at GBP 200B, but there could be a growing shift within the MPC as policy makers struggle to curb the risk for inflation.

Earlier this week, BoE board member Charles Bean said price growth “may prove a little more persistent next year” than the central bank expects as higher energy prices fuel inflation, and went onto say that there remains an “unusually wide” range of dissenting views amongst the committee as the economic outlook remains clouded with high uncertainty. At the same time, Mr. Bean warned that tight credit conditions paired with the austerity measures could impeded on the economic recovery, and the majority of the MPC may look to retain a wait-and-see approach throughout the first-half of the year in order to balance the risk for the region. In turn, the BoE is likely to refrain from releasing a policy statement as it maintains its current policy in March, but currency traders may show a bullish reaction to the rate decision as interest rate expectations gather pace. Investors are pricing a 17 percent chance for a 25bp rate hike next week according to Credit Suisse overnight index swaps, while borrowing costs are expected to rise at least 75bp over the next 12-months as the outlook for growth and inflation improves.

However, the technical forecast paints a mixed outlook for the GBP/USD as there appears to be a bearish divergence in the relative strength index, and the recent developments certainly raises the risk of seeing a large correction in the exchange rate as the oscillator continues to come off of its recent highs. As a result, the pound-dollar may continue to consolidate going into the following week, but the market reaction to the BoE rate decision should generate a clearer picture for future price action.

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