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

Published August 14th, 2009 - 05:20 GMT

Consumer prices in the U.K. are expected to weaken in July, with economists forecasting inflation to grow at an annual pace of 1.5% from the previous year, and price pressures are likely to remain subdued throughout the second-half of the year as the nation faces its worst economic downturn in over half a century.



Trading the News: U.K. Consumer Price Index

What’s Expected
Time of release:                  08/18/2009 08:30 GMT, 04:30 EST
Primary Pair Impact :          GBPUSD
Expected:                              1.5%
Previous:                               1.8%


Impact the U.K. Consumer Price Index report had over GBPUSD for the past 2 months

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

June 2009

07/14/2009 08:30 GMT

1.8%

1.8%

+34

+31

May 2009

06/16/2009 08:30 GMT

2.0%

2.2%

+38

+3



  June2009 U.K. 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.

 


 
May 2009 U.K. Consumer Price Index

Consumer price in the U.K. grew at an annual pace of 2.2% in May to hold above the Bank of England’s 2% target however, price pressures are likely to remain subdued throughout the second-half of the year as the nation faces its worst economic downturn in over half a century. At the same time, the CPI rose 0.6% from April, led by a 3.1% surge in  alcohol and tobacco, while transportations costs rose 1.5% during the month following the rise in crude oil. Moreover, BoE markets director Paul Fisher added that the depreciation in the British pound has helped to keep inflation above the central bank’s target, while the statistics office noted higher taxes on alcohol and tobacco has helped to support price growth throughout the region. Nevertheless, as the central bank sees a risk for price growth to hold below target, the BoE pledged GBP 125B in asset purchases to mitigate the downside risks for inflation, and the central bank may take further steps to steer the economy out of the recession.




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 weaken in July, with economists forecasting inflation to grow at an annual pace of 1.5% from the previous year, and price pressures are likely to remain subdued throughout the second-half of the year as the nation faces its worst economic downturn in over half a century. The advanced 2Q GDP reading reinforced a weakening outlook for the U.K. as the growth rate plunged at annual pace of 5.6% from the previous year to mark the biggest decline since recordkeeping began in 1955, and the slump in private-sector spending may continue to weigh on economic outlook as households face a weakening labor market paired with tightening credit conditions. Moreover, a report by the Bank of England showed home equity withdrawals fell at a record pace during the first quarter, while consumer credit unexpectedly slipped to 0.1B from a revised reading of 0.2B in May, and the data foreshadows a dour outlook for personal consumption, which is one of the biggest drivers of growth, as banks remain reluctant to lend. As a result, businesses may continue to scale back on production and employment as they face fading demands from home and abroad, and firms may pass along the rise in input costs onto consumers in an effort to weather the slump in global trade. Meanwhile, the Bank of England held the benchmark interest rate at 0.50% earlier this month, but unexpectedly expanded its asset purchase program by GBP 50B to GBP175B in order to maintain its 2% target for price growth, and the weakening outlook for inflation may lead the central bank to take additional steps to stimulate the ailing economy as policymakers acknowledge that the recession ‘appears to have been deeper than previously expected.’ At the same time, former MPC member David Blanchflower argued that the central bank should ‘keep the stimulus going’ in order to support a sustainable recovery, and continued to see a risk for deflation as growth prospects remain weak. As fears of a double-dip recession intensify, a drop in price growth could weigh on the outlook for future policy as the BoE maintains its dual mandate to ensure price stability while fostering full employment, and a dismal CPI reading is likely to drag on the exchange rate as investors scale back expectations for a rate hike next year.

Trading the given event risk favors a bearish forecast for Cable as market participants anticipate consumer price to fall further in July however, price action following an enhanced CPI report could set the stage for a long British pound trade as the economic outlook improves. Therefore, if the annual rate of inflation grows 1.8% or more from the previous year, 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 place our initial stop at the nearby swing low (or 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.

On the other hand, the slump in private consumption paired with the downturn in global trade reinforces a dour outlook for economic activity, and a drop in the annual rate of inflation is likely to drag on the exchange rate as investors weigh the outlook for future policy. As a result, if the CPI slips to 1.5% or lower from the previous year, we will favor a bearish forecast for Cable, and will follow the same setup for a short pound-dollar trade as the long position mentioned above, just in reverse.



 

 

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