GBP/USD: Trading the Change in U.K. Public Sector Borrowing

Published September 17th, 2009 - 10:26 GMT

The British pound is likely to face increased selling pressures over the next 24 hours of trading as economists forecast public sector borrowing to increase GBP17.6B in August, and the slump in tax revenues paired with the rise in jobless claims are likely to weigh on the economic outlook as Standard and Poor’s see a risk for Europe’s second largest economy to lose its AAA credit rating.



Trading the News: U.K. Public Sector Net Borrowing


What’s Expected

Time of release:                  09/18/2009 08:30 GMT, 04:30 EST

Primary Pair Impact :          GBPUSD

Expected:                              17.6B

Previous:                               8.0B


Effects the U.K. Public Sector Net Borrowing has had over GBPUSD for the past 2 months

 


July 2009 U.K. Public Sector Net Borrowing

Public sector borrowing in the U.K. surged GBP 8.0B in July amid expectations for a GBP 0.6B rise, with the national debt rising to 56.8% of GDP from 56.6% in the previous month. The breakdown if the report showed the government’s revenue slipped 15% from the previous year to mark the biggest decline since the series began in 1998, while spending jumped 7.5%, and the data is likely to add pressures on Britain’s AAA credit rating as market participants speculate the deficit to surpass the HM Treasury’s  forecast for a shortfall of GBP 175B in the fiscal year beginning in April. At the same time, Chancellor of the Exchequer Alistair Darling argued that the data remains “broadly in line” with expectations, but went onto say that the government will need to maintain the expansion in fiscal policy to steer the nation out of its worst economic downturn in over half a century.

 


June 2009 Public Sector Net Borrowing

The U.K. budget deficit jumped GBP 13.0B in June to mark the biggest shortfall since comparable records began in 1993, and  the slump in tax revenues paired with the rise in jobless claims may continue to weigh on the economic outlook as the region faces its worst recession since the post-war period. A deeper look at the report showed tax revenue slipped 5.7% from the previous year, while public spending increased 2.8%, and the expansion in fiscal policy is likely to add pressures on Britain’s credit rating as Standard and Poor’s see a risk for the deficit to reach 100% of GDP. At the same time, the Organization for Economic Cooperation and Development forecasts the budget shortfall to reach 14% of GDP in 2010, which is the highest projection amongst the Group of 20, and the slump in public finances is likely to weigh on the exchange rate as investors maintain a weakened outlook for economic activity the U.K.



What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:


If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the GBP against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on GBPUSD ahead of the data release.

Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the GBP against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on GBPUSD ahead of the data release.




How To Trade This Event Risk

The British pound is likely to face increased selling pressures over the next 24 hours of trading as economists forecast public sector borrowing to increase GBP17.6B in August, and the slump in tax revenues paired with the rise in jobless claims are likely to weigh on the economic outlook as Standard and Poor’s see a risk for Europe’s second largest economy to lose its AAA credit rating. A report by the Office for National Statistics showed claims for unemployment benefits rose 24.4K to 1.61M in August to mark the highest reading since 1995, with the claimant count rate increasing to 5.0% from 4.9% in July, and the labor market is likely to weaken further over the coming months as businesses continue to scale back on production and employment in order to weather the downturn in global trade. Moreover, the preliminary GDP report showed government  spending increase 0.8% in the second quarter amid an initial forecast for a 0.6% rise, while business investments plunged 10.4% from the first three-months of the year, and the expansion in fiscal policy is likely to hamper the outlook for public finances going forward as the nation faces its worst economic downturn since the post-war period. Nevertheless, as Chancellor of the Exchequer Alistair Darling projects the growth rate to expand towards the end of the year and pledges to increase the tax rate for individuals who earn GBP 150K+ in April, the efforts should help to curb the outlook for public debt however, as the Bank of England sees a risk for a slower recovery, the HM Treasury may expand policy over the coming months in an effort to foster a sustainable recovery. At the same time, BoE Governor Mervyn King held a caution tone speaking in front of the House of Commons Treasury Committee as he anticipates the downturn in employment to drag on economic activity going into the following year, and policy makers may take additional steps to stem the downside risks for growth and inflation as the outlook remains highly uncertain. Meanwhile, a report by the National Institute of Economic and Social Research showed the GDP forecast increased 0.2% in August to mark the first rise since May 2008, with the International Monetary Fund projecting the economy to expand at an annual rate of 0.2% in 2010, and the enhancement in the economic landscape may lead the government to tighten fiscal and monetary policy in the following year as growth prospects improve. However, as former MPC member David Blanchflower anticipates the central bank to increase the scope of its asset purchase program as the recovery remains “fragile,” the downturn in interest rate expectations is likely to drag on the exchange rate as investors weigh the outlook for future policy.

Trading the given event risk favors a bearish outlook for Cable as market participants anticipate the government deficit to rise at a record pace in August but nevertheless, price action following a less-than-expected rise in public borrowing could set the stage for a long pound-dollar trade. Therefore, if the budget shortfall comes in at GBP 9.0B or less, we will look for a green, five-minute candle following the release to generate a buy-entry on two lots of GBP/USD. Once these conditions are met, we will place our initial stop at the nearby swing low (or a reasonable distance), and this risk will determine our first objective. Our second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to lock-in our profits.

On the other hand, the slump in tax revenues paired with the rise in government spending encourages a weakening outlook for public finances, and fears of a slower recovery may weigh on the exchange rate as policy makers hold a caution outlook for the economy. As a result, if borrowing increases GBP 17.6B or greater from July, we will favor a bearish forecast for Cable, and will follow the same strategy for a short pound-dollar trade as the long position mentioned above, just in reverse.

 


 

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com

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