Bullish Sentiment As The Pound Rallies Against Global Currencies

Includes: FXB, GBB
by: Orit Nathan Mahalal

Currency traders have been enjoying frenetic activity around the recent GBP rally in global Forex markets. The US dollar dropped against major world currencies, while the UK sterling continued to enjoy a bull run. This news was sparked by the BoE (Bank of England) announcement that it would upgrade its forward guidance policy. The Euro for its part was markedly weaker as a result of comments made by a senior ECB official. Examining the numbers confirms the facts: the exchange rate between the GBP/USD recently reached 1.6571 - the most favourable rate for the pound since January 29, 2014. The BoE raised expectations for a positive economic growth figure for 2014. Analysts are now pointing to the fact that currency traders looking to boost their stockpiles of USD are perfectly poised to do so at this present time. In fact, the same analysts point to the fact that the GBP/USD ratio is heavily tilted in favour of the GBP. It is expected that the United Kingdom will be one of the first leading economies to raise interest rates during 2014, perhaps not during the second quarter. It was initially expected that the Bank of England would only raise interest rates once the unemployment rate dipped beneath 7%. That benchmark has all but been put to rest as the UK economy continues to steamroll ahead in 2014.

Many investors throughout the UK believe that it is high time that interest rates were increased, perhaps during the last quarter of 2014. Judging by the economic performance of the UK economy over the past six months, expectations are bullish with regards to unemployment, growth prospects and stability. The exchange rates between the GBP/USD are highly tilted in favour of the former, with the GBP/Euro ratio hitting a one-year high recently. Inflation in the euro zone is just a smidgen over .7%, putting pressure on the Bank of England to reduce interest rates. But this action may not work well for the UK since it would lead to a weakening of the UK currency in respect of other currencies like the Euro and the USD. UK inflation data has already been released and confirms the position of the Bank of England. Analysts were bang on target in their expectation that the inflation rate level was pegged at 2%. The quarterly inflation report which is released by the Bank of England directly impacts on the GBP exchange rate with other currencies. Once this information is made public, investors have a better insight into monetary policy going forward. Recently, the Governor of the Bank of England - Mark Carney - made remarks about changes to the forward guidance policy. This is being done in an effort to arrest interest-rate hike speculation.

Back in August 2013, the Bank of England decided to link labour market performance (unemployment rates) and interest rates. Since then, UK unemployment has dropped precipitously by 0.6 percentage points. The current unemployment rate is hovering around 7.1%. While everybody has lauded the increased employment levels in the UK, policymakers are a bit cautious since this improvement has taken many by surprise. Further, the gross domestic product expansion in the UK reflected a 1.5% growth during the latter half of 2013. In tandem with this growth, the Bank of England is all too aware that universal accessibility to credit facilities is paramount to continued growth. As a result, there's been widespread reluctance to raise interest rates for fear of stifling economic growth prospects in 2014. The Bank of England does not want to reduce consumers' access to credit facilities either. Now the Bank of England Governor will be focusing on indicators other than the CPI and the unemployment rate. The recently-released quarterly inflation report will likely be used by Gov. Carney to make alterations to the forward guidance policy. Analysts expect the Governor to include multiple indicators such as underemployment and wage growth. It is however a known fact that the rapid reduction in unemployment may in fact easily be extrapolated to include multiple other economic indicators in the United Kingdom. As mentioned earlier, the GBP/USD currency cross rates have moved in favour of the pound sterling of late. This is due in no small part to the announcement of the forward guidance program. Speculators were also expecting that the Bank of England would raise interest rates well ahead of time. In the event that this does take place in the foreseeable future, the GBP will depreciate against the USD. The same scenario is likely to occur with other major currencies such as the NZD, AUD, CAD, and the EURO.

Predictions & Insights: The British Pound ahead of The Inflation Report Week

The pound has been holding steady of late against major world currencies. The absence of financial data makes it vulnerable to outside influences and other technical considerations. The February 2014 inflation report reflects minimal price increases for 2014. In fact, the projections are the most positive in several years.

Percentage Increase in Price

Above is the CPI fan chart for February 2014 as released by the BoE (Bank Of England).

The GDP fan chart for 2014 shows an estimated projection growth of between 1% and 3% on the top end for the United Kingdom for 2014 and beyond. Based on the projections of past growth, the extrapolation for the upcoming year can be seen in the graph below.

Percentage Increase in Output

The inflation report provides in-depth analysis as well as inflation projections based on market analysis. This sets the tone for the BoE's Monetary Policy Committee regarding interest rates. It also provides information that can be used to ascertain the UK inflation rate. Among others, the inflation report provides information on costs and prices, output and supply, demand, asset prices and money, and medium-term inflation prospects and associated risks. The inflation report released in February 2014 touts the UK recovery and the fact that inflation has returned to the two percentage point target. The UK economy is enjoying easier credit access, lower uncertainty and greater stimulus via monetary policy. Strong employment gains have greatly reduced unemployment have helped speed up growth. The unemployment rate is on track to reach 7% by April/May 2014. Analysts expect inflation to remain within a narrow range during the forecast period in question. During the course of 2013, the UK economy grew by 1.9% - the strongest in 6 years. This was the result of continued consumer spending and the accessibility of credit. The central bank reserves remain at £375 billion. And in respect of inflation, the CPI dropped one percentage point between June 2013 and December 2013. Commodity prices have dropped by 10% during 2013 and oil prices have dropped by 6% during the same period. The committee voted to maintain the 0.5% bank rate and the figure of £375 billion in purchased assets.

So, considering all the facts, how should investors position themselves in light of this analysis? I would recommend to invest in GDP, which has good promises to rise, but as always, doing it cautiously and taking into consideration all the risks involved and the unexpected changes in the currency market, as well in the UK economy scene which might take place during the next quarter of the year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.