Fundamental Forecast for British Pound: Mixed

Monetary policy expectations are in focus for the British pound, with correlation studies suggesting the influence of relative yield spreads over the exchange rate is at the strongest relative to that of risk sentiment since August of last year. Needless to say, this puts the spotlight squarely on the Bank of England as it delivers its monthly interest rate decision. This seemingly points toward weakness considering Mervyn King and company are widely expected to keep benchmark borrowing costs as well as the size of its asset-purchase program unchanged from the ultra-loose Great Recession settings now in place, although the currency is likely to be better-supported against some of its major counterparts relative to others.

The markets appear convinced that the Bank of England will offer no changes in standing monetary policy. Indeed, a Credit Suisse gauge tracking the priced-in probability of a rate hike at the upcoming meeting puts the chance of an increase at a paltry 7 percent. This appears to be reasonable. Core inflation slowed for the first time in six months in March and although overall GDP grew in the first quarter, the 0.5 percent increase served to help counterbalance the drop in the three months through December rather than push the economy forward. Furthermore, while leading economic indicators have shown steady improvement since mid-February, the overall down trend in place since June 2009 remains in place, hinting output has yet to make a material break from the post-crisis malaise. On balance, this suggests the central bank will need to see further evidence over the months ahead before committing to removing stimulus. As much is likely to be reinforced with the updated Inflation Report set to be published in the following week, with the real market-moving bit of monetary policy news being the release of minutes from this week’s meeting on May 18.

With this in mind, it seems reasonable for Sterling to come under selling pressure against the currencies whose corresponding central banks are making more aggressive strides toward unwinding stimulus than the BoE as well as those where significant tightening has already taken place (i.e. Australia). This amounts to an outlook calling for the Pound to weaken against the majority of its major counterparts, with the notable exception of the US Dollar and the Japanese Yen. Needless to say, the Bank of Japan will not be raising interest any time soon so it can safety be concluded that Sterling will maintain its yield advantage against the Japanese unit even as the BoE continues to dither, while the greenback is likely to remain under pressure as traders rush to borrow as much in USD on the cheap until QE2 expires in June.

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