Failing to overtake the 1.5700 technical barrier, the GBPUSD has fallen ahead of key economic events scheduled for the next five sessions.  Namely, market participants are targeting the preliminary gross domestic product figures earlier in the week.  This report is just one of about four that is expected, and may be cause for further pound sterling position squaring in the near term.

UK BBA Mortgage Approvals – July 24^th 8:30 GMT

British Bankers Association reports are expected to show that mortgage approvals may have improved in the month of June.  Compared to May’s 30,200 approvals, June’s figures are forecasted to be a bit higher at 31,400.  Rosier than one would expect, the figures may be supported by a seemingly resilient labor market that showed an improvement in the country’s unemployment rate for the most recent three month period.  The rate improved to a 9-month low in the second quarter as reported last week.

UK Preliminary Gross Domestic Product – July 25^th 8:30 GMT

The Office of National Statistics is anticipated to show that the UK economy gained slightly in the second quarter, improving to a quarterly contraction of 0.2%.  The figure, although still indicative of a shrinking economy, is an improvement over the 0.3% quarter over quarter slide seen in the last reading.  This isn’t that far from reality.  With the country already in the midst of the final stages of production for the 2012 Olympics, the country could have sustained a pickup in activity – buoying a temporary lift in the economic figure.  However, the positive gain is expected to have rather muted effects – with the annualized contractions still at a lackluster 0.3% decline.

CBI Industrial Orders Expectations – July 25^th 6:00 GMT

Playing second fiddle to the session’s GDP report, the CBI industrial orders expectations report is likely to only add to any positive momentum built on the market moving report.  Forecasts are for the survey to show improvement in sentiment by the country’s surveyed manufacturers – rising to a reading of -10 versus last month’s actual reading of -11.  Any disappointment, through a lower than anticipated figure, could call the GDP results into question and jeopardize a sterling positive day.

Technical Outlook

Technically speaking, the GBPUSD currency major looks to remain under pressure heading into the highly anticipated GDP report.  Already failing to break through 1.5750 resistance, and confirming a noted rising wedge pattern, the current decline could extend to 1.5530 61.8% fib support.  A downside violation of the fib support would open scope for a 1.5500 test (medium term target).

Source: FXtrek IntelliChart™

Copyright 2001-2012 FXtrek.com, Inc.

Pound sterling gains were halted in the overnight following the release of the Markit/CIPS UK construction PMI survey.  Although still relatively positive, survey results were worse than had been anticipated by analysts, leaving some still skeptical of any short term UK economic recovery.  As a result, the British pound traded slightly lower to yesterday’s high at 1.5841 against the US dollar.  The exchange rate hit as high as 1.5869 in midday trading yesterday.

According to the construction sector survey, index readings dipped to a 51.4 in January – below the December 53.2 mark.  Although this is the 13th consecutive month of gains, the figure stands as the weakest reading in 4 months and compounds fears that the recession isn’t just over yet.  Notably, however, today’s survey findings still portend to a thin silver lining for Europe’s second largest economy.  According to subcomponent readings, confidence among construction companies and business leaders continues to be optimistic – although the same companies are unlikely to add to current payrolls.

The recent round of optimism seems to have been spurred on by improving month to month comparisons in recent weeks.  Notably, manufacturing sector activity improved to an 8-month high, while confidence among consumers recovered to the highest in almost the same time period.

Given the overwhelming and rising optimistic sentiment, today’s results may be temporary as traders begin to shift their sentiment to a potential turnaround in the UK economy.  This should support the current sterling momentum – if at least for another session or two.

The last few years have been volatile for the British Pound. In 2007, it touched a 26-year high against the US Dollar, before falling to a 24-year low a little more than one year later. During the throes of the credit crisis, analysts predicted that it would drop all the way to parity. Alas, it has since managed to claw back a substantial portion of its losses, and finished 2010 close to where it started.

At the moment, however, there are two contradictory forces tugging at the Pound, which could send up upwards against the Euro but lower against the US Dollar. The first is the sovereign debt crisis in the EU, which flared up dramatically in 2010 and currently threatens to crippled the Euro. I will offer more commentary on this issue in a later post; for now, I just want to point out its role in supporting the Pound. While the Dollar is the Euro’s chief rival, many traders have turned to the Pound (and the Swiss Franc) because of their regional proximity. “As long as the euro-zone debt crisis is in the focus of the market, it will be the main driver of euro-pound,” summarized one strategist.

The second force (or set of forces) is propelling the Pound in the opposite direction. Basically, the UK economy remains depressed. Thanks to an unexpected contraction in the fourth quarter, GDP growth in 2010 was an exceptionally modest 1.7%. This was hardly enough to compensate for the average annual growth of .1%/year from 2006 to 2009, and send the Pound tumbling. Forecasts for 2011 and 2012 have since been revised downward to about 2%.

In order to spur Britain’s export sector, the Bank of England has deliberately acted to hold down the Pound, which it has managed to achieve through a combination of quantitative easing and low interest rates. “For a long time that’s what we were targeting, and we managed to get it down by about 25 percent — the exchange rate, that’s had a huge benefit to the U.K. economy,” a former member of the monetary policy committee recently admitted.

An unintended byproduct of this policy has been price inflation. At 3.75%, the inflation rate is among the highest in the industrialized world, and certainly the highest among G4 currencies. At the very least, the Bank of England will have to suspend any aspirations to match the Fed in printing more currency and expanding its QE program. It will probably also have no choice but to raise interest rates, which it might otherwise not have done until the economy is on more solid footing. The markets are currently projecting an initial rate hike of 25 basis points in the third quarter, and for the benchmark rate to exceed 1.5% by the end of the year, compared to .5% currently.

It’s difficult to say how the currency markets will make sense of this. Given that real interest rates will remain negative (due to inflation), it seems unlikely that any yield-seeking investors will suddenly start targeting the British Pound. In addition, given that the risk of ‘stagflation’ in the UK is now real and that the government is set to assume a record amount of new debt over the next few years, risk-averse investors will probably stay away. According to the latest Commitment of Traders report, speculators are already starting to establish bearish positions against the US Dollar.

While the Pound looks vulnerable, the big unknown is ultimately the EU fiscal crisis. If one of the peripheral members leaves the Euro, as some commentators predict will finally happen, then all bets (for the Pound, etc.) are off.

The rally in the Pound, which lifted it 10% from trough to peak, appears to be fizzling. The Pound is already down 3% in the last two weeks, and is trending downward. It now stands at a four-week low against the Dollar.

Looking back at the Pound’s two-month rise, it’s not hard to understand why it was unsustainable. You can see from the charts below that there was a strong correlation with the Euro and the S&P 500 over the same period of time. This suggests that the Pound rally was less a product of changing fundamentals and more due to a sudden decrease in risk aversion.

By no coincidence the rally in equities, the Euro, and a handful of other proxy vehicles for risk, all came to and end at the same time as the Pound. In a nutshell, the markets are back to focusing on fundamentals. Namely, the risk of a double-dip recession, combined with a lack of resolution in the Eurozone debt crisis is causing investors to think twice about making bets that entail any kind of risk.

In this regard, the Pound is especially vulnerable. On the economic front, the UK economy only grew by 1.1% in the second quarter, with economists predicting only modest growth for the year. According to an economist for the Bank of England, “It would be ‘foolish’ to rule out a renewed downturn.” Evidently, his bosses agree: “The Bank of England last week said growth will be weaker than it forecast in May, citing “continuing fiscal consolidation and the persistence of tight credit conditions.”According to a recent poll, almost half of British households are pessimistic about the country’s economic prospects in the near-term: “The proportion of pessimists is marginally lower than in July, but is higher than in any other month since March last year.”

Ironically, the efforts of the British government to curb spending and cut the deficit are perceived as making matters worse. Since these measures won’t be offset by lowered taxes, they will directly lead to lower economic growth. Given that both the Pound and UK bond prices are rising (implying an increased risk of default), I think this reinforces the point I made last week about the markets not caring at all in this economic climate about increasing national debt.

The icing on the cake is inflation. A British think-tank made headlines by predicting that the UK economy will emerge from recession next year, “But once recovery is under way, he thinks, then the Bank of England’s quantitative easing scheme, which pumped £200 billion into the economy in the wake of the credit crunch, will have terrible consequences.” Specifically, the think-tank is forecasting inflation of 10% and a benchmark interest rate of 10%.

For now, this remains a distant prospect, and analysts are focusing on the fact that the economy will probably re-enter recession before it can officially exit from it. As for the Pound, forecasts are not optimistic: “Bears in a Bloomberg survey of strategists outnumber bulls 29 to 12, while TD Securities in Toronto, the most-accurate forecaster in the six quarters ended June 30, has the lowest estimate, predicting sterling will depreciate 15 percent versus the dollar by year-end.” According to the most recent Commitments of Traders report, institutional investors were still net long the Pound as of August 10. Futures prices, meanwhile, have moved in lockstep with spot prices, which suggests that futures traders are still waiting for more data before they weigh in on the Pound.

Personally, I’m having a tough time coming up with a prediction. I tend to agree with the characterization of “the foreign exchange markets post-crisis as a beauty parade with ugly contestants.” In other words, all of the major currencies are currently plagued by poor fundamentals. It’s hard to say that the Pound is in better or worse shape than the Dollar or the Euro. Still, given the way that markets have been trading, a return to (global) recession would not be kind to the Pound.

Setting a triumphant tone against both the U.S. dollar and the Euro, the British pound gained significantly in the overnight over speculation of – yep, you guessed it, interest rates.  Although there is plenty of evidence of short covering from the previous sell off in recent days, the tone of momentum reeked of carry trade bets made on recent comments made by Bank of England Governor Mervyn King and a rather dovish minutes report.

According to this morning’s Bank of England minutes, central bankers voted unanimously to hold interest rates at a record low of 0.5 percent.  As “recent developments were not sufficiently compelling to justify” a change in current monetary policy, the BoE saw nothing in justifying any rate increases as well as an expansion of the Quantitative Easing program.  The plan is currently set at 175 billion pounds.  Although the report was stable and expected, any further momentum higher in the currency will likely be dependant on the November 5^th meeting.  During this time, central bankers will review growth forecasts in order to better assess the current economic situation.  Forecasters have already noted that the UK economy may have very well exited the recession back in the third quarter with a 0.7 percent tick higher.  However, any visible weakness in the GDP figure may prompt another 25 billion pound increase in the asset purchase program, giving the underlying pound a bearish tone.

Notably, Governor Mervyn King was quoted in an individual article saying that interest rates in the U.K. will likely rise in the future “at some point”.  He also cautioned that “it would be wise to take this into account”.  Not only does this signal a potential shift in monetary policy, but also a shift in personal attitude as it seems that the UK monetary authority may see some signs of a stable economic foundation.  The statement also helps to fodder a sentiment that interest rates may be set to rise in the broader market, leaving the U.S. as the last player that will consider the option.  On this ticket, the British pound skyrocketed higher from the 1.6384 close yesterday in New York, to trade as high 1.6598.  Although a medium term pullback is highly likely, the sentiment may give plenty of support for anti-dollar buying throughout the day.

A busy morning in New York as U.S. employment indicators and announcements by both the ECB and BOE are setting the tone for the market.  It seems that U.S. dollar weakness continues to prevail, given the momentum from last night’s positive Australian employment report and further views that an economic recovery, in the global sense, is in the works.  As a result, buyers have pushed the Euro higher to trade $1.4765 against the U.S. dollar with the British pound breaking the $1.6000 figure to trade at $1.6052.

U.S. initial jobless claims surprised the masses as first time claimers of unemployment benefits fell last week to a level not seen since the beginning of the year.  For the week, applications dropped by an impressive 33,000 to 521,000 – significantly lower than the 540,000 that was predicted by analysts.  Today’s weekly Labor Department report conflicts with last week’s non-farm payrolls figure, giving some hope that there is now stabilization in the broader labor market.  Subsequently, the four week moving average has now dropped a haircut below 540,000, setting up for another interesting employment release next month.

As expected both the European Central Bank and the Bank of England have kept their interest rates steady following announcements this morning.  However, key elements have now sparked some speculation to the downside, which may help the greenback gain some traction against both the Euro and pound sterling.

Keeping interest rates at a record low of 0.50%, the Bank of England is likely waiting till November to make any real decisions regarding monetary policy.  Although confidence has edged up slightly, along with some recovery in the housing sector, things haven’t really improved in the UK economy.  Manufacturing continues to place a lag on overall productivity as labor concerns continue to swirl – last print has unemployment in the country soaring to 7.8 percent annually.  The fragility of the economy has now placed even more emphasis on any possible extension of the Quantitative Easing plan.  Already at 175 billion pounds, there is still hope that the plan will be extended another 25 billion in order to pump even more funds into the market in order to prop up the economy.  Such a move will place significant pressure on the British currency as supply will overrun demand.  As a result, look for upcoming economic data to heavily influence the central bank November decision.

European Central Bank members additionally decided to keep to their key benchmark interest rate, citing that current level of interest rates remain “appropriate” for the time being.  This decision is likely to remain for an extended period given the fact that economic growth seems choppy at best for the region.  Production has improved slightly, contrary to overall labor markets which continue to remain weak.  Should policy makers increase lending rates to soon, risks remain abound that current nascent growth will be choked off.  As a result, the ECB will likely continue to work with lenders to free tight lending markets and hope that firm stabilization will come sooner than later.  Nonetheless, the underlying currency continues to be well supported against the U.S. dollar on worrisome economic fundamentals in the world’s largest economy.

Scheduled on the same day, both the UK inflation report and FOMC rate decision are expected to jolt the FX market this week, at least a tad. Set for Wednesday, the UK report is anticipated to show a further slowdown in consumer and producer prices with additional central bank statements alluding to a continued slowdown in the UK economy. Recent reports show nothing but support for the near term decline in prices. For the month of June consumer prices rose a paltry 1.8 percent from the year before as producer prices rose at the lowest level in eight years. What pound bulls will most likely be attuned to will be the probable downgrade in overall growth by the Bank of England. Following the expansion in quantitative easing of an extra 50 GBP billion last week, traders are expecting the worse for the subsequent statements. If the same fears are proven right, the underlying currency will come under pressure as further accommodative policies are likely to emerge in the coming quarters. Even worse has been speculation of a deflationary trap in the country, where prices continue to move low enough to choke off spending by both consumer and producer sectors, leading GDP further lower. Adding fuel to the fire has been Governor King’s refusal to completely rule out further expansion of cash injections into the financial system.

To Buy or Not To Buy

Currency traders will also be eyeing the Federal Reserve’s interest rate decision later on in the day, following the UK inflationary report. Although most, if not all, are expecting the benchmark rate to remain the same, the question hovers over any further plans to expand the program to buy long dated government Treasuries. Heading into the month of August, the Federal Reserve has already fulfilled a majority of its previous commitment, purchasing approximately $250 billion of the allotted $300 billion. In addition, the central bank is set to purchase $1.45 trillion in mortgage debt by the end of the year. All of this in order to boost liquidity and lending while ensuring that benchmark rates remain relatively stable. However, given the recent unemployment report, will there really be a need to expand the program? Market participants answer with a resounding “no”. Given the uptick in non-farm payrolls last week, stable economic indicators and a relatively thawed credit market, central bankers will favor completion of the program over expansion. The sentiment is likely to give risk tolerance a boost as slim anticipation still lingers of a rise in interest rates at the tailend of Q4.

Retailers Find a Silver Lining

US retail sales are expected to have kept positive in the month of July, which would be the third consecutive month in a row and a definitive sign of economic stabilization. Set for release on Thursday morning, the report is forecasted to show a rise of 0.5 percent. Good support for market bullishness, speculative sentiment will be focused on the contribution and effects of the Cash for Clunkers program on the actual figure. Beginning last month, the administration’s plan for boosting auto sales may temporary increase the figure, leading some to believe the improvement will be a flash in the pan. Estimates are for the ex-auto number to be considerably lower, rising by only 0.1 to 0.2 percent for the month.