Forex 24x7

By Michael Trinkle, ForexTraders The British Pound has performed incredibly well versus the U.S. Dollar during the months of June and July.  While most investor and media attention is locked on the Euro due to the Sovereign Debt Crisis, the Pound has quietly posted huge gains of nearly 2000 pips since early May.  This strong rally in the Pound has been a result of 2 primary causes.  First, the U.S. has obviously entered into a period of severe economic slow-down.  The talks out of the Federal Reserve are extremely bearish, Fed Chairman Ben Bernanke has made it clear that he and his team are considering instituting further quantitative easing measures in order to inject fresh stimulus into the economy.  The market, of course, does not want to see a further supply of U.S. Dollars into the economy, which is essentially what quantitative easing does, and so it has sold the U.S. Dollar heavily.  The Federal Reserve has been very clear that interest rates will not be raised form an extended period of time. Second, the Bank of England has been giving mixed signals concerning economic outlook.  On one hand, BOE Governor Mervyn King has released some very dovish words over the last few weeks concerning the economic outlook in England.  He has said England has a long way to go for a full economic recovery.  However, inflation is somewhat of a threat in England, which has stoked some concerns that the BOE may be forced into raising interest rates in 2010.  If the BOE were to raise rates, this would, of course, increase the yield spread between the Pound and the Dollar and investors love to buy currencies with high yield and sell those with low yield. When Interest rates were slashed by Central Banks around the world at the outset of the 2008 Global Credit Crisis, no one knew how long interest rates would have to remain at historically low levels.  Among the G3 (U.S., EuroZone, and England) the Bank of England is the only Central Bank that has actually had a board member vote for an interest rate hike.  In fact, Andrew Sentance has now voted twice for an interest rate hike at the BOE.  Inflation has broken out of target levels set by the BOE, and Sentance believes the BOE must raise rates in order to stem inflation. How Much Longer Can the Pound Rise? Since much of the Pound’s rise has been due to the fact they will most likely hike rates before the U.S., if the economic recovery begins to show significant signs of slow-down in the U.K., we could see the Pound begin to fall quite sharply.  The new government in the U.K. is set on fiscal tightening and reigning in government spending.  Although this is a very sound ideological and political idea, many economists fear that it could be economically devastating.  The U.K. economy has not established a self-sustaining recovery, and if austerity measures are introduced prematurely out of political zeal, it could have dire effects on the economic recovery.  On Wednesday, the U.K. released Services PMI, which was expected to come out slightly higher than last month at 54.5.  Instead, the reading disappointed to the downside at 53.1 for the worst reading in 12 months.  This was quite a bad sign for the U.K.  PMI readings work on a boom/bust reading.  If the figure is above 50, that means the manufacturing sector is booming or expanding, but if the reading comes in below 50, then the sector is bust, or contracting. The details of the reading this month stated that public spending had decreased significantly and demand had waned.  This is potentially a very bad situation in the U.K.  Basically, that means the austerity measures that are being introduced are beginning to have a negative impact on growth.  As the U.K. reigns in spending, numbers such as PMI may begin to show signs of contraction which could be devastating as the U.K. economy tries to thwart a double-dip recession.  Many economists are expecting these PMI numbers to begin reading below 50 in the coming months. On Thursday, the Bank of England will release its official bank rate decision and it will release a rate statement.  While no surprises are expected with the interest rate, the official statement from the BOE may offer significant insight into the BOE economic outlook.  The low PMI reading may be addressed.  If the BOE begins to voice concerns that austerity measures in the EuroZone and U.K. may weigh on economic development and growth in the coming months, then we may see a top soon form in the Pound and see a bit of a correction.  The pound definitely has plenty of room to correct to the downside.  The Pound has registered only 1 day of depreciation versus the U.S. Dollar since July 22nd. To the downside, the 1.5780 area should offer in initial support for the Pound, and the 1.5550 area should offer strong support if it does begin to correct heavily.  To the upside, it may find difficulty breaking much further to the upside without some correction.  The 1.6000 level is a major key psychological area and with weakening economic data, the Pound may have to take several stabs at the 6000 level before it finally breaks through.  If it does make a clean break, however, then it should face strong resistance at the 1.6080 level. Investor attention is quickly turning to the Non-Farm Payroll release in the U.S. on Friday morning.  The figure is expected to show further job losses for a second consecutive month.  Much of the Pound rally as of late has been due more to weakened U.S. figures rather than strong Pound figures, so if this data does confirm that job losses are continuing to mount in the U.S., then we could see a strong run at the 1.6000 level yet this week.  However, if the Non Farm Payrolls do surprise to the upside and show fewer job losses than expected, then we may see some pressure begin to build on the Pound, and we could see the beginning stages of a possible correction. More articles from ForexTraders….