British Pound Outlook Hinges On BoE Amid Bets For More QE

By David Song, Currency Analyst

Fundamental Forecast for British Pound: Bearish

The British Pound pared the decline from earlier this month as the EU Summit propped up market sentiment, but the sterling may struggle to hold its ground next week as market participants see the Bank of England taking additional steps to shield the U.K. economy. Although the BoE is widely expected to keep the benchmark interest rate at 0.50%, there’s growing speculation that the central bank will embark on more quantitative easing as the sovereign debt crisis continues to dampen the fundamental outlook for the region.

A Bloomberg News survey shows 39 of the 41 economists polled see the Monetary Policy Committee expanding the Asset Purchase Facility beyond the GBP 325B target, and the central bank may continue to carry out its easing cycle in the second-half of the year as Governor Mervyn King turns increasingly cautious towards the region. Indeed, Mr. King sounded rather downbeat on the economy while testifying in front of the Treasury Committee earlier this week, and it seems as though the central bank head will try to sway the MPC to expand the balance sheet further in order to combat the downside risks for the U.K. economy. As the U.K. remains in a technical recession, fears of a prolonged economic downturn may prompt additional votes to further easing, but we may see another 5-4 split in July as the stickiness in underlying price growth raises the threat for inflation. Although the BoE curbed its forecast for growth and inflation, we saw core consumer prices tick higher in May, with the annualized figure expanding 2.2%, and the majority may continue to endorse a wait-and-see approach as the fundamental outlook for Britain remains clouded with high uncertainty.

Although the GBPUSD had an impressive rally going into July, the pair appears to have carved out a lower top in June, and the lack of momentum to hold above the 61.8% Fibonacci retracement from the 2009 low to high around 1.5690-1.5700 may produce a short-term correction ahead of the BoE rate decision as market participants weigh the outlook for monetary policy. However, a rise in the BoE’s asset purchase program could force a sharp decline in the exchange rate, and we may see the GBPUSD make another run at the 50.0% Fib (1.5270) should the central bank strike a very dovish tone for the region. - DS
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