Over the past year, British pound strength has dominated the FX markets as the currency has gone on to breach 26 year highs above 2.01 back in April. The recent rally of GBP/USD looks ready to take aim on that level once again, but with a double dose of UK event risk scheduled within the next week, will the pair break above the psychologically important price or mark a tumultuous top?
[B]Handing Off the Labour Torch to Gordon Brown[/B]
On May 1, 2007, British Prime Minister Blair marked the tenth anniversary of his leadership, and also indicated that he would establish his date of departure from office the following week. Chancellor of the Exchequer Gordon Brown, who has been endorsed by Mr. Blair, was the clear favorite and faced no major opposition whatsoever. On June 27th Tony Blair?s official departure could cause the British pound to show a similar reaction to 1997, when the Prime Minister was initially elected. In the early days of May 1997, GBP/USD showed a rocky 200 point range amidst conflicting sentiment, as the Labour Party?s reputation for massive amounts of public spending ran counter to Gordon Brown?s surprise decision to make the Bank of England independent while also hiking rates 25 basis points. Interest rates eventually won out, as the British Pound rallied nearly 800 points over the follow two months.
[B]GBP/USD Daily Chart (April-July 1997)
[B]Will the British Pound Repeat 1997?[/B]
In order to gauge the reaction of the British pound this time around, we must consider not only the changing political tides, but the current economic scenario as well. First, Mr. Brown, the longest serving chancellor of modern times, has often been applauded for helping guide the British economy through booms and busts. However, the role of Prime Minister would give Mr. Brown far greater control, so it is worth noting what kind of policies he will likely enact. Mr. Brown tends to favor “big government” like Mr. Blair, and has gained some opposition in his quest to raise taxes in order to pay for increased spending. Looking forward, it is expected that Mr. Brown may consider cutting corporate taxes in order to keep large firms in the UK. While businesses will surely see the potential of lower taxes as a major benefit of Brown-leadership, his reputation for liberal public spending is not typically taken as a bullish measure for the national currency. Nevertheless, as a member of the Labour Party, Mr. Brown?s policies will not represent a huge shift from the status quo and thus, may not create as much of a shake-up in FX market volatility.
Turning to the UK economy: expansion continues to move along at a brisk pace and a booming housing market has helped fuel inflation - creating ample conditions for policy tightening by the Bank of England. In fact, after the minutes of the June policy meeting showed a surprising amount of votes for a rate hike, 33 out of 37 economists polled by Bloomberg now predict that the central bank will raise rates 25 basis points on July 5. However, given the lofty levels of GBP/USD (the pair is still near 26 year highs), there could be limited upside potential for the pair. Furthermore, given the generally lackluster publicity surrounding Brown?s move to a greater leadership role, any bearish moves from resistance at 2.01 may only be exacerbated.
[B]GBP/USD Daily Chart (July 2006 - Present)
There is one major caveat to consider going into the next month: If the Bank of England decides to raise rates on July 5th and also signals additional hikes for later in the year, the British pound may move to challenge the record highs once again without pausing at resistance. However, any hawkish sentiment may wane over the next few weeks as current monetary policy is bound to put a cap on inflation pressures and severely limit the potential for higher interest rates over the course of the next year.