GBPUSD Monthly Technical Forecast
There was some mild room for optimism in February with the inability to extend below the previous multi-year trend lows by 1.3500 from January, finally ending a sequence of 6 consecutive monthly lower lows. However, the pair did manage to post a 7th consecutive monthly lower high and 7th consecutive monthly negative close to keep the intense bear trend firmly intact. Key levels to watch in March will be 1.4990 and 1.4000 (February high/Psychological). A sustained break back below 1.4000 will expose a direct retest of the 1.3500 multi-year lows from January, and then 1.3000 further down, while back above 1.4990, will delay bearish momentum and suggest that a meaningful base is in place. It is worth noting that the pair is the most overextended of any major pairing and as such, building longer-term positions at current levels would not be recommended. A close look at the monthly RSI confirms with the oscillator now sitting at life-time lows by 15.
GBPUSD Interest Rate Forecast
The British Pound continued its decline against the dollar after the BoE cut its benchmark interest rate to 1.00% from 1.50% which was the lowest since its inception in 1694. As the pound’s yield advantage disappeared it continued to lose ground to the dollar, but the rate of decline slowed as the spread between the BoE overnight rate and US Fed funds Rate fell from -96 to -53. However, interest rate expectations have lost their ability to reflect growth prospects as they approach zero and may lose their ability to predict future price action. Indeed, the BoE and other central banks have had to revert to off balance sheet measures as growth prospects continue to decline which is starting to be reflected in currency valuations.
The central bank has already asked for permission from Prime Minster Gordon Brown to embark on quantitative easing and is expected to begin by printing 50-150 billion pounds to buy assets. Although markets may see interest rate expectations become flat following another rate cut by the BoE, it wouldn’t reflect the dour outlook for growth which could lead to more sterling weakness.
British Pound – US Dollar Valuation Forecast
The British Pound replaced the New Zealand dollar as the most undervalued currency against the U.S. dollar in February, and came in as the second-best performer against the greenback during the month, which suggests that buying interest is beginning to build as market participants forecast the Bank of England to conclude its easing cycle in March. As BoE Governor Mervyn King adopts quantitative easing to better-manage monetary policy and is expected to hold borrowing costs at the record low to stimulate the economy, the British Pound’s appeal is likely to become attractive to investors as policy makers continue to take unprecedented steps to steer the economy out of a deepening recession however, as investors continue to curb their appetite for risky assets, deteriorating fundamentals paired with mounting turmoil in the U.K. banking sector is likely to weigh on the exchange rate over the near-term.
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 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 overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.
