Fundamental Forecast for British Pound: Bullish

Much of the sterling’s price action in the coming days will be determined by market sentiment on the US dollar as this week saw investors and traders alike continue to jettison the greenback on concerns over domestic fiscal imbalances and ultra-loose monetary policy from the Fed. The pound stalled out just short of the 1.66-handle on Thursday as dollar losses accelerated.

Traders will be eying economic data out of the UK next week for an update on the state of the economy, with GDP figures on Wednesday headlining even risk. Consensus estimates call for Q1 GDP figures to rise to 0.5% q/q, up from a previous contraction of 0.5%, while year-over-year figures are expected to print at 1.8%, up from 1.5% y/y a month earlier. The data may shift rate hike expectations for the Bank of England which is now widely seen holding rates in May. Credit Suisse is factoring a 10% chance of a 25 basis point rate hike at the next central bank meeting.

Next week the FOMC reports its interest rate decision with expectations that the Fed will surely leave rates unchanged. However the event risk peaks at the first ever FOMC press conference following the rate announcement, where Chairman Bernanke will have a televised speech to address the nation on the Feds monetary policy stance. This new endeavor aims to make markets more transparent and reduce speculation about the central bank’s outlook. Increasingly hawkish rhetoric or an unlikely announcement that he Fed will end QE2 earlier than anticipated may see the dollar pair some of the steep declines we saw this week. Nonetheless, dollar pressure will remain so long as equity markets and higher yielding assets continue to out-perform.

The burden falls on the BoE’s most vocal hawk Andrew Sentance to weigh on other voting members of the Monetary Policy Committee. With Sentance stepping down in May, time to gather enough support from the 9 voters to raise interest rates may be running out as members cite a surprise fall in March CPI and slow wage growth. Expectations for a rate hike have accordingly been pushed back until August with Deutsche Bank expecting no more than a 25 basis point hike for 2011.

The week ahead will be a telling one for the pound after breaking through the 61.8% long standing Fibonacci extension taken from the 2009 and 2010 troughs at the 1.64-handle earlier this week. Continued dollar weakness sees a likely retest of the 1.66-handle, with topside targets for the sterling eyed at the 1.6660 and 1.6710. A break below the 1.65-figure sees support at 1.6420 and 1.6350.

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