British Pound US Dollar Exchange Rate Forecast

[B]GBPUSD Monthly Technical Forecast[/B]

The market seems to have found a base for now by 1.3500 and it remains to be seen whether we are merely in the process of a bearish consolidation or possibly looking to carve out a major bottom. At current levels there are no compelling opportunities and we recommend looking to favor the broader structure which is still bearish, by selling into rallies above 1.5000 and towards 1.5500. Key levels to watch over the coming weeks come in by 1.5375 and 1.4395.

[B]
GBPUSD Interest Rate Forecast[/B]

Aggressive Bank of England monetary policy easing has played a large part in British Pound weakness, but limited scope for further action suggests that interest rates may play little role in GBP/USD outlook. Indeed, it seems as though both the US Federal Reserve and the BoE have virtually exhausted their ability to boost monetary supply in their respective economies. Overnight Index Swaps show expectations that Bank of England rates will remain above Federal Reserve yields through the coming 12 months, but the almost-negligible rate spread makes this almost irrelevant to the FX market.

Instead we will continue to monitor the trajectory of global risk sentiment and its effect on the British Pound/US Dollar pair. The 20-day correlation between the GBP/USD and the US S&P 500 currently trades near its highest levels in the past 10 years. This suggests that Bank of England and US Federal Reserve actions will affect the GBP/USD based on ability to move risky asset classes.

[B]
British Pound – US Dollar Valuation Forecast[/B]

The British Pound has corrected a bit higher through April but remains below its PPP-implied exchange rate. Fundamental and risk considerations point in opposite directions, clouding the near-term outlook. A rebound in risk appetite is likely to help narrow the value gap in the near term, with GBPUSD still over 90% correlated with the MSCI World Stock Index. That said, it is reasonable to suppose that traders will begin to change focus to interest rates as the recovery continues, pointing to GBPUSD downside on expectations that the UK will see the deepest recession of the G7 nations (as forecast by the IMF). This would imply that borrowing costs will be comparatively slow to return higher in the UK, giving the Dollar an advantage. On balance, the current valuation profile argues that it is prudent to remain on the sidelines for the time being until price action offers greater clarity and a wider valuation gap to be exploited.

[B]
What is Purchasing Power Parity?[/B]

One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies pairs that are undervalued against their PPP exchange rate have the size of the value gap denoted in [U][B]RED[/B][/U], while those that are overvalued are denoted in [U][B]GREEN[/B][/U].