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Currency Forecast: GBP/USD Outlook

Like the Euro, the British Pound has also taken a sharp slide against the dollar. The fundamentals behind the GBPUSD's slide are very different from that of the EURUSD. For the British pound, we are finally seeing, what we knew would happen sooner or later. After raising interest 5 times last year, the UK 's impressive growth showed no signs of slowing. This continued to be true for most of the first half of 2005 with most economic data sending mixed signals. It was only in May of this year that we finally had some directional clarity on the health of the UK economy. Consumer spending has slowed and housing market indicators are collectively pointing to a slowdown in the sector. Meanwhile the trade deficit has also widened causing some concern for export demand while the inflation risk according to the central bank was tilted towards the downside as of the beginning of June. These developments have prompted two monetary policy committee members to vote in favor of lowering rates at the June 8/9 meeting.

BoE Changes Course - Talk Of Rate Cuts Sends Pound Tumbling
You can either call the Bank of England fickle or dynamic, but there seems to be a lot of dissent and shift in views over the past few months. In March and April of 2005, the decision to keep rates unchanged was also 7 to 2, but the 2 dissenters voted in favor of raising rates. In May, one of them moved back to neutral camp, leaving only one favoring a rate hike. In June, the remaining hawk voted in favor of keeping rates unchanged while 2 different members voted in favor of lowering rates. So for the time being, the BoE is neutral with a dovish bias, yet as we have seen, this could change rather quickly over the next few months if the trend of economic data also changes.

Carry Traders Getting Out
The monetary policy bias of the central bank is particularly important for the British pound because GBP crosses are laden with speculators. Although there are countries and currencies that offer higher interest rates than the UK offers, the pound has traditionally been one of the favorite currencies for speculators to go long for carry trades. The UK offered not only 4.75% interest rate differentials and were amongst one of the first to raise rates, they also offered one of the most liquid financial markets in the world. For large hedge funds that are also involved in the carry trade, this is particularly important as they may actually end up buying pound denominated investments after converting their dollars to pounds. Through 2003 and 2004, the UK was also one of the most resilient economies among the world's industrial leaders. Unemployment remained low while the country enjoyed 44 consecutive quarters of expansion - the longest period of uninterrupted growth for the country in over 200 years. In fact, the UK was the only G-7 nation to avoid a recession in the last 5 years. For the time being, with the US raising rates and the UK standing pat, the carry trade differential continues to shrink, giving carry trade speculators a good reason to take profits. If the BoE actually does lower rates, the sell-off in the GBPUSD could exacerbate, as any remaining speculators will capitulate. Keep watching the trend of data and the central bank's bias for more insight on the future direction of the GBPUSD.

Blair Slated To Take Up EU Presidency
One interesting development to watch will what Blair does with the EU Presidency that his country is slated to take over in July of 2005. So far, the EU is in crisis, with the UK leading the pack of those who refuse to budge. At the EU Summit in June, the UK and France spent the whole time fighting over rebates and agricultural subsidies and not the future on the European Union. Although acknowledging that their rebates were an anomaly that needs to be fixed, the UK refuses to give up the rebates unless France overhauls their agricultural subsidies, which they call another anomaly. It will be interesting to see how Blair's camp tries to fix things because this time, they are going to be held accountable.

Technical Outlook
Sterling lost a lot of the shine that it had during the first six months of 2005, after the pair reached a multi year high at 1.9550 and then proceeded to collapse down to 1.8000. It is now attempting to retrace from those lows, but has repeatedly failed to break above the 1.8300 figure that is marked by a 61.8 Fibonacci retracement. A break above the 1.83 level could lead to an extension move to 1.86, while a break below the 1.81 level will send the pair down to 1.80, and the 1.77 level. Indicators are currently pointing to a possible trend reversal. Stochastic is neutral at 57.18. ATR is rising as volatility picked up, signaling an intermediate bottom. ADX (DMI) is at 27.50 and falling, signaling a trend reversal, with DI+ about to cross above the DI- thus issuing a buy signal.

Key Levels: Sterling lost a lot of the shine that it had during the first six months of 2005, after the pair reached a multi year high at 1.9550 and then proceeded to collapse down to 1.8000. It is now attempting to retrace from those lows, but has repeatedly failed to break above the 1.8300 figure that is marked by a 61.8 Fibonacci retracement. A break above the 1.83 level could lead to an extension move to 1.86, while a break below the 1.81 level will send the pair down to 1.80, and the 1.77 level. Indicators are currently pointing to a possible trend reversal. Stochastic is neutral at 57.18. Enlarge Chart View
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