Fundamental Forecast for British Pound: Neutral

The British pound tipped higher going into April and the rebound in the exchange rate may gather pace ahead of the Bank of England interest rate decision next week as investors speculate the central bank to gradually normalize monetary policy over the coming months. A Bloomberg News survey shows all of the 32 economists polled forecast the BoE to hold the benchmark interest rate at 0.50% while maintaining its asset purchases at GBP 200B, and the MPC may refrain from releasing a policy statement as it maintains its current policy.

Nevertheless, BoE board member Paul Fisher provided some clarity on the MPC’s exit strategy while delivering a speech earlier this week and said that the “plan is to raise rates” before unwinding the GBP 200B in quantitative easing as the European banking system remains battered. At the same time, Martin Weale argued that the central bank should increase the key rate as rising commodity prices continue to fuel inflation expectations, and went onto say that monetary policy should be normalized sooner rather than later as it maintains its dual mandate to ensure price stability while fostering full-employment. In turn, investors are pricing a 6 percent chance for a 25bp rate hike next week according to Credit Suisse overnight index swaps, but see borrowing costs in the U.K. rising by more than 75bp over the next 12-months as the central bank anticipates the headline reading for inflation to reach 5 percent in the coming months. However, there could be another 6-3 split within the MPC as the recovery in the U.K. cools, and the central bank may look to support the real economy throughout the first-half of the year in order to stem the risks for a double-dip recession.

As the economic docket for the following week is expected to reinforce a weakened outlook for future growth, the fundamental developments are likely to spur a bearish reaction in the British Pound, and the GBP/USD may consolidate in the days ahead as investors weigh the prospects for monetary policy. A report by the Bank of England is expected to show Britons paying down another GBP 5.7B in home loans during the last-three months of 2010, while the purchasing manager index for construction is expected to fall back to 54.8 in March from 56.5 in the month prior. In addition, producer prices in the U.K. are expected to increase at an annual pace of 5.1% in March after expanding 5.3% in the month prior, and the slower pace of growth and inflation could bear down on the exchange rate as interest rate expectations falter.

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