[B]British Pound / US Dollar Monthly Technical Forecast[/B]
The recent break to 2009 highs beyond 1.6745 keeps the constructive and bullish trend intact with a medium-term higher lower now confirmed by 1.5980. A fresh upside extension is now underway with the market projecting a move back towards the 1.7500 area before and sign of a top. Setbacks should now be supported ahead of 1.6700, with only a break below to compromise the structure and outlook.
[B]British Pound / US Dollar Interest Rate Forecast[/B]
The British Pound/US Dollar currency pair has shown relatively little sensitivity to interest rate developments through recent trading. FX markets have sent the GBPUSD to fresh peaks despite the fact that Overnight Index Swaps show little change in yield forecasts, and there is little reason to believe that markets will subsequently grow more sensitive to GBP/USD rate differentials.
It has been far more significant to monitor financial market sentiment as seen through the S&P 500 and other key risk barometers. The rolling medium-term correlation between the GBPUSD and the S&P remains near record highs, and we have many reasons to believe that this will continue to be the case through the foreseeable future.
[B]British Pound / US Dollar Valuation Forecast[/B]
As with the Euro, the gap between British Pound spot and PPP-implied exchange rates has widened over recent months, catalyzed by the market’s seemingly insatiable appetite for risky assets. Indeed, the sterling’s relative superiority in value and yield has seen it outperforming other major European currencies against in the greenback. However, this also means that the UK unit is more vulnerable to a reversal of a current rally, an outcome that seems reasonable considering global shares look decidedly overvalued having finished July trading at the highest level relative to earnings since October 2003. After adjusting for inflation, the pace of global GDP growth registered at 2.7% that year having been accelerating since 2001, implying earnings that all but certainly expanded at a healthier rate than anything we are going to see this year. It seems only a matter of time before the stock markets experience a rude awakening and begin correcting sharply lower, dragging the Pound along for the ride. In the meantime, continued gains may be considered in the context of creating a more pronounced overvaluation, presenting an increasingly more attractive selling opportunity ahead.
[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 Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.