British Pound Strength May Endure on Confirmation of Record UK GDP Decline (Euro Open

The British Pound may shrug off confirmation that the UK economy shrank the most since 1979 in the first quarter despite downward revisions to private consumption and investment with traders already pricing in sluggish performance in the foreseeable future. Overnight data saw the Bank of Japan upgrade their economic outlook for the first time since 2006.

[U][B]Key Overnight Developments[/B][/U]

[B]• Bank of Japan Upgrades Economic Outlook for First Time Since 2006
• Euro Higher, British Pound Range-Bound in Overnight Trading[/B]

[U][B]Critical Levels[/B]

The [B]Euro[/B] extended gains in Asian trading hours, adding as much as 0.5% against the US Dollar. The [B]British Pound[/B] remained range-bound, oscillating in a well-defined 70-pip band above 1.5820.

Asia Session Highlights[/B][/U]

The [B]Bank of Japan [/B]kept overnight interest rates at 0.10%, as expected, and maintained their monthly purchases of government bonds at 1.8 trillion yen. The bank did another step toward easing lending conditions however, announcing it will now take foreign bonds as collateral for borrowing. US, UK, German and French government debt will be accepted. Most notably, the central bank upgraded their economic outlook for the first time since July 2006, saying growth will begin to recover in the second half of the 2009 fiscal year, an improvement from previous expectations of a rebound in the first half of FY2010. The BOJ expects the recovery will be export-driven, saying domestic demand will probably continue to weaken.

[U][B]Euro Session: What to Expect[/B][/U]

The second revision of [B]UK Gross Domestic Product[/B] is set to confirm that the economy shrank -1.9% in the first quarter, the most since 1979. Although the headline figure is likely to remain unchanged, a number of key components are expected to see downside revisions to paint an even bleaker view of the struggling economy. Most notably, the fall in Private Consumption is expected to be scaled up to -1.0% from the originally reported -0.7% while the drop in Gross Fixed Capital Formation (i.e. investment) is expected to nearly double the originally reported result of -2.3% to print down -4.1%.

Although this is surely bad news for economy, the ability of the release to meaningfully derail the recent rally in the [B]British Pound [/B]seems limited. Sterling traders heard everything they needed to about growth prospects when the Bank of England’s quarterly inflation report revealed expectations inflation will remain below the target 2% until 2012 as the economy takes a slower path to recovery. Indeed, this week saw the UK unit shrug off a weak CPI report as well as news that rating agency S&P downgraded their UK outlook from “stable” to “negative”.

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