GBP/USD: Trading the U.K. CPI Report

Published September 11th, 2009 - 09:30 GMT

Consumer prices in the U.K. are expected to rise 0.3% in August, with the annual rate of inflation forecasted to grow 1.4% from the previous year after rising 1.8% in July, and a weakening outlook for price growth is likely to weigh on the British pound as the Bank of England projects the CPI to fall below 1.0% this year.



Trading the News: U.K. Consumer Price Index


What’s Expected

Time of release:                  09/15/2009 08:30 GMT, 04:30 EST

Primary Pair Impact :          GBPUSD

Expected:                              1.4%

Previous:                               1.8%


Effects the U.K. Nationwide Consumer Confidence had over GBPUSD for the past 2 months

 


July 2009 U.K. Consumer Price Index

Consumer prices in the U.K. unexpectedly held flat in July, with the annual rate of inflation rising 1.8% from the previous year, and the data encourages an improved outlook for the nation as the government takes unprecedented steps to soften the landing of the ailing economy. A deeper look at the report showed food prices weakened for the second month in July, with transportations costs rising 3.8% on the back of higher oil prices, while prices for clothing and footwear plunged 2.7% during the month as businesses continued to conduct heavy discounts. As the Bank of England holds an enhanced outlook for growth and inflation, the MPC is likely to maintain a neutral tone going forward as policy makers anticipate economic activity to improve throughout the second-half of the year, and long-term expectations for higher borrowing costs should drive Cable higher as investors speculate the BoE to tighten policy over the next 12 months.


June 2009 Consumer Price Index

The headline reading for inflation weakened to an annual rate of 1.8% in June and slipped  below the central bank’s 2% target for the first time since September 2007, and the outlook for price growth remains weak as policymakers see a risk for a slower recovery. The breakdown of the report showed a 1.4% rise in transportation costs as oil prices continued to move higher, while prices for clothing and footwear slipped 1.5% from the previous month as businesses slashed prices to lure consumers. Meanwhile, Bank of England Deputy Governor Charles Bean said that the economy is in for a ‘long haul’ as economic conditions remain far from favorable, and the central bank may take further steps to stem the downside risks for growth and inflation as they forecast price pressures to hold below target until 2011. As a result, market participants speculate the BoE to expand its asset purchase program and utilize the remaining GBP 25B allotted by the HM Treasury in the months ahead.




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

Consumer prices in the U.K. are expected to rise 0.3% in August, with the annual rate of inflation forecasted to grow 1.4% from the previous year after rising 1.8% in July, and a weakening outlook for price growth is likely to weigh on the British pound as the Bank of England projects the CPI to fall below 1.0% this year. At the same time, the preliminary GDP reading showed the economy contracted at a slower pace in the second quarter than initial expected, with private and public spending crossing the wires stronger than anticipated, and the extraordinary efforts taken on by the government should help to stem the downside risks for growth and inflation as the central bank adopts unconventional tools to steer the nation out of the worst recession since the post-war period. Moreover, 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, while the International Monetary Fund raised its growth outlook for the nation and expects the economy to expand at an annual rate of 0.2% in 2010, and the improvement in the economic landscape should help to bolster price pressures throughout the region as growth prospects improve. In addition, a report by the Office for National Statistics showed producer prices in the U.K. rose for the sixth consecutive month in August, led by higher oil prices, while the Nationwide home price index increased for the fourth month, and the data suggests price pressures may fall at a slower pace going into the following year as the central bank continues to pump newly created money into the economy. The Bank of England held the benchmark interest rate at the record-low of 0.50% in September and maintained its GBP 175B asset purchase program as the board upholds its dual mandate to ensure price stability while fostering economic growth however, former MPC member David Blanchflower anticipates the central bank to ease policy further over the coming months as the economic recovery remains “fragile.” Nevertheless, as investors anticipate the central bank to tighten monetary policy over the next 12 months, a better-than-expected CPI reading is likely to drive the exchange rate higher as the economic outlook improves.

Trading the given event risk may not be as clear cut as some of our previous trades as the annual rate of inflation is anticipated to weakening in August but nevertheless, a rise in the monthly CPI paired with the jump in producer prices may drive the British pound higher as the outlook for inflation improves. Therefore, if consumer prices grow at an annual rate of 1.6% or greater, we will look for a green, five-minute candle following the release to confirm a buy entry on two-lots of GBP/USD. Once these conditions are met, we will set our initial stop at the nearby swing low, or a reasonable distance, and this risk will establish our first target. Our second objective 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 preserve our profits.


In contrast, the slump in private sector spending paired with the dovish rhetoric held by the BoE reinforces a weakened outlook for inflation, and price action following a dismal CPI reading is likely to stoke increased selling pressures on Cable as investors scale back expectations for higher interest rates. As a result, if consumer prices unexpectedly fall in August, with the annual rate of inflation slipping to 1.4%  or lower, we will look to sell the Sterling, 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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