Fundamental Forecast for British Pound: Bullish

The British pound ended the week at its strongest level against the greenback since January 2010, as data showed today that producer prices were rising faster than anticipated, further strengthening the argument for a rate hike by the Bank of England, despite the Monetary Policy Committee’s decision to maintain the key benchmark interest rate at 0.50 percent for the coming month.

As the Bank of England has sustained its interest rate at a record low, it appears that, despite increasing prices pressures on the British economy, the Monetary Policy Committee has prioritized the recovery over taming the fastest inflation rate in more than two years. As the government acts austerity measures, policymakers seem to be waiting to gauge whether or not the British economy can handle a draw down in fiscal policy, before withdrawing monetary policy. However, given some key events in the week ahead, Bank of England policymakers may not be able to hold onto historically low rates for much longer. Key housing data is released on Monday, and it has been well-documented how poorly the U.K.’s housing market has fared in the wake of the recession. House prices continue to remain depressed, and there is little reason to suggest that prices could have rebounded by a significant margin in the prior period. Jumping ahead to Wednesday, unemployment data is due; while the unemployment rate is expected to remain on hold at 8.0 percent, a drop in the underlying jobless claims figure could help provide support to the notion that the British economy is stable enough to raise rates. Backtracking to Tuesday, however, will yield the most important event for the week. With consumer price index data due, that is forecasted to another 4.4 percent increase year-over-year, coupled with producer price data from March that showed a 14.6 percent jump in prices on a year-over-year basis, the British economy is creeping closer to falling into a state of stagflation – high unemployment, high inflation, and low growth rates.

Accordingly, it appears the markets are actively pricing in a rate hike in the near-future as price pressures continue to build. The Credit Suisse Overnight Index Swaps shows a 42.0 percent chance of a 25-bps rate hike at the next meeting, with 75.4-bps priced in over the next 12-months. With the differential between interest rates between the Pound and the US Dollar widening, and furthermore, with the markets expecting the Bank of England to raise rates before the Federal Reserve begins to wind-down its $600 billion stimulus plan, the GBP/USD pair is set up to be an exceptionally sensitive pair over the coming week, with even the slightest miss on data potentially sending traders into a flurry amid boosted interest rate expectations.

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