British Pound / US Dollar Monthly Technical Forecast
Difficult to determine whether we are in the process of attempting to carve a major lower top in the 1.7000 area ahead of the next drop below 1.3500 or are looking for a higher low ahead of a fresh upside extension beyond 1.7000 and back towards the 2 handle. For now however, at a minimum, it looks as though the market wants to trade lower with sighs set on the 1.5000 area over the coming weeks. This, after the triggered major h&s top by 1.6000 on the weekly chart.
British Pound / US Dollar Interest Rate Forecast
September saw the pound continue to lose ground to the dollar but recent stability may be founded on the fact that interest rate expectations for both countries are currently identical. Indeed, the U.K. has been on lock step with its cousin from across the ocean throughout the crisis and as both continue to show signs of weakness it is appropriate the outlook for both stands even at 74 bps. Manufacturing activity in both countries has started to wane after positive gains through the middle of the year as the labor markets continue their slides.
The BoE continues to keep their foot on the gas pedal as they recently took measures to help small businesses manage their liquidity. The upcoming rate decision may see the central bank add to their quantitative easing methods and add to recent sterling weakness. However, non action and a hawkish tone could significantly raise the outlook for interest rates and provide pound support.
British Pound / US Dollar Valuation Forecast
The deck is stacked heavily against the British Pound: prices remain firmly overvalued against the PPP-implied GBPUSD exchange rate, momentum is clearly against the sterling after two months of crippling losses, and the priced-yield outlook continued to favor the Fed (albeit by a very narrow margin). Continued losses appear likely, with over one thousand pips to go before prices approach “fair” value levels.
What is Purchasing Power Parity?
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.
Written by Joel Kruger, Technical Currency Strategist; John Rivera, Currency Analyst; Ilya Spivak, Currency Analyst for DailyFX.com