Fundamental Forecast for British Pound: Bearish

The sterling has fallen more than 3.3% since the start of April as expectations for a rate hike from the Bank of England diminished. The central bank’s inflation report warned of strengthening inflationary pressures with Governor Mervyn King raising forecasted annual inflation to 4%-5% in coming the coming months, more than double the 2% targeted rate. Weaker than expected industrial production data this week highlighted the dilemma facing MPC members as inflation risks are skewed to the upside while growth risks remain skewed to the downside.

The pound’s losses accelerated on Friday as yet another bout of risk aversion engulfed markets. The sterling fell as the greenback rebounded, sending the pair to a 5 Ã,½ week low at the 1.6150 support level. The move saw the pound break below trend line support that dates back to late December 2010, and suggests the further weakness for the currency. Our contrarian Speculative Sentiment index confirms this biased, with traders remaining net long the sterling.

A break below interim support at 1.6150 sees targets at the 1.61-handle backed by 1.6070 and the long term 50% Fibonacci extension taken from the 2009 and 2010 trough at the 1.60-handle. This extension converges with trend line support dating back to May of 2010 and should provide the sterling with stronger support. Topside resistance is eyed at 1.6250 backed by 1.63 and 1.6355.

Looking ahead, the pound will be increasingly vulnerable to CPI data on Tuesday and the BoE minutes on Wednesday. Consensus estimates call for inflation to rise to 0.7% m/m from a previous read of 0.3% m/m, while the year on year figure is seen jumping to 4.1%. If the data prints as expected, it will confirm the recent rise seen in consumer prices and although the economy continues to suggest sluggish growth, rate hike expectations may drift higher. Expectations will be further influenced by the release of the BoE minutes from the most recent policy meeting where traders will get a better idea of the central banks outlook and dissention among the voting members. If the vote tightens to 5-4 from the 6-3 seen in the past few MPC meetings, traders will begin to factor in future rate hikes and subsequently the pound may rally.

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