Fundamental Forecast for British Pound: Bearish

The British pound fared mediocre over the course of the week, losing ground against most of the major currencies, though finding strength against the Canadian Dollar, the Euro, and the U.S. Dollar. Indeed, the Sterling was in the middle of the road in terms of performance, bid higher against the currencies of the world’s two economic pillars, the Euro-zone and the United States, while appreciating against the Loonie on concerns that dampened U.S. growth would ultimately weigh on the Canadian economy.

Data this week out of the United Kingdom wasn’t particularly encouraging, although much significant data wasn’t released in the last full-week of July. The headline data from the week was most notably the gross domestic product figure from the second quarter, which was disappointing, to say the least. Although the quarterly reading of 0.2 percent fell in line with expectations, it still represented weak growth, at best, after a 0.5 percent quarterly growth rate in the first quarter. Similarly, on a yearly basis, growth was subdued at a 0.7 percent annualized rate in the second quarter. Part of the blame for declining British growth can be immediately pointed towards lower consumer spending, which has led to erosion in the housing sector, as evidenced by Friday’s Nationwide Housing prices data, showing another 0.4 percent trimmed off prices over the past year in July.

The data due for the coming week will likely provide increased volatility across Sterling-based pairs, although until there is resolution to the United States debt ceiling, data from any other country will likely have little standing effect on the currency markets. Nonetheless, the headline event for the week comes on Thursday, with the rate decision for August on the docket. The Bank of England’s Monetary Policy Committee is expected to maintain its key benchmark rate at 0.5 percent at its meeting on Thursday, as the MPC’s focus remains on economic growth rather than on reducing inflation, which has subsided in recent months. Still, the United Kingdom is facing an inflation rate of 4.2 percent, more than double its target of 2 percent. Policy makers agree that the economic outlook is not stable enough to withstand higher rates at the current time, given the eroding condition of other aspects of the economy, mainly the housing and labor sectors.

The overnight cash rate has remained at 0.5 percent since March 2009, when it was lowered by 50-basis points to its current level. With economic recovery expected to be shaky in the short and medium-term, the MPC will likely hold the bank rate at 0.5 percent through the end of 2011, as inflationary pressures have been alleviated in recent periods. The Overnight Index Swaps point towards the same conclusion, with a mere 3.0 percent chance of a rate hike expected at the meeting on Thursday. As such, rhetoric following the Bank of England decision will guide the Sterling, of which is expected to remain dovish.

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