GDP Fundamental Analysis 10 August 2009

By William Doody
The effects of last week’s surprise decision by the Bank of England to intensify their quantitative easing program continue to ripple through the markets. After sharply rising Friday on the heels of better than expected economic data, including an improvement in the U.S. unemployment report, European equities have given back some ground. Likewise, the Pound has declined modestly against major currencies as traders wonder whether or not the BOE’s move is a cause for significant worry about the medium-term prospects for the British economy. The key event of the week will be Wednesday’s release of U.K. jobless claims and inflation data. We would position accounts for a negative surprise on both results.

The BOE’s decision to extend and increase the quantitative easing program suggests to us that short-term economic data may be decidedly negative. In particular we are concerned about the prospects for a “jobless recovery” in both the U.S. and U.K. The lack of job creation will make it difficult, if not impossible, for any significant increase in consumer spending especially as access to new credit remains challenging for many individuals. At the same time, the past several weeks have seen an increase in prices, with a primary concern being the rise in energy. We believe this sets the stage for a potentially higher-than-expected move in the inflation report.

We expect that a negative surprise on either or both of these data releases would cause selling of the Pound, as it would raise the prospect of a “double-dip” recession and increase the likelihood of further easing by the BOE. This is complicated by the extensive actions already taken by the central bank. For this reason, we continue to be pessimistic regarding the Pound. We do not believe that currency markets have priced this scenario in their calculations.

Trading recommendation:

Close GBP long positions / consider small short GBP