trading news reports

GBP/USD: Trading the Bank of England Interest Rate Decision

The British pound is likely to face increased volatility over the next 24 hours of trading as market participants anticipate the Bank of England to expand its asset purchase program in November, and speculation for further easing could drag on the exchange rate throughout the remainder of the year as investors weigh the outlook for future policy.

Trading the News: Bank of England Interest Rate Decision

What’s Expected
Time of release:        11/05/2009 12:00 GMT, 07:00 EST
Primary Pair Impact :    GBPUSD
Expected:         0.50%
Previous:         0.50%

Impact the Bank of England Rate Decision has had on GBPUSD over the last 2 meetings

October 2009 Bank of England Interest Rate Decision

The Bank of England kept the benchmark interest rate unchanged at 0.50% in October and maintained its GBP 175B asset purchase program in an effort to jump-start the ailing economy, and the central bank may hold a neutral policy stance over the remainder of the year as policy makers see the nation emerging from the recession. The minutes of the meeting showed the MPC voted unanimously to uphold its current policy in place, but said that “there were differences over” the outlook for inflation as the board expects volatile price growth over the medium-term. Nevertheless, Governor Mervyn King said borrowing costs will have to rise “at some point” in an article on the Herald newspaper as policy makers hold an improved outlook for growth and inflation, but held a cautious tone and said that “long-term challenges” remain as economic conditions normalize.

September 2009 Bank of England Interest Rate Decision

The central bank in the U.K. held borrowing costs at the record-low in September, and maintained its GBP 175B in asset purchases in an effort to steer the nation out of its worst recession since the post-war period, and the board is likely to hold a dovish outlook for future policy. The Bank of England minutes showed the MPC voted unanimously to maintain its current policy however, Governor Mervyn King said that “a larger asset-purchase program could still be justified” as the banking system remains weak. Moreover the BoE said that the recent rebound in economic activity “could mark the start of a virtuous upward spiral for the economy,” and went onto say that “inflation would probably be higher in the short-term” than the board had anticipated as policy makers expect growth prospects to improve throughout the second-half of the year.

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 volatility over the next 24 hours of trading as market participants anticipate the Bank of England to expand its asset purchase program in November, and speculation for further easing could drag on the exchange rate throughout the remainder of the year as investors weigh the outlook for future policy. A Bloomberg News survey shows all of the 60 economists polled forecast the central bank to hold the benchmark interest rate at 0.50% this month, while a deeper look shows a median estimate for the emergency program to be increased to GBP 225B from GBP 175B in the previous month as the economy fails to emerge from the recession in the third quarter. The advanced GDP reading showed economic activity contracted 0.4% from the second quarter amid expectations for a 0.2% expansion, with the annual rate of growth slipping 5.2% from the previous year, and fears of a protracted recovery may lead the MPC to take additional steps in an effort to jump-start the ailing economy. A report by the BoE showed consumer credit weakened for the third month in September, while M4 lending weakened at an annual pace of 1.7% during the third quarter to mark the lowest rate growth on record, and the data reinforces a dour outlook for private spending as households and businesses continue to face tightening credit conditions paired with instability in the banking sector. In addition, consumer prices held flat in September for the first time since comparable records begin in 1996, with the annual rate of price growth slipping to a five-year low of 1.1% from 1.6% in August, and easing price pressures may lead the central bank to act as policy makers attempt to balance the risks for the economy. Nevertheless, former BoE dove David Blanchflower argued that the central bank should “keep stimulating the economy” and said that the MPC should expand its bond-purchasing plan by GBP 50B to shore up bank lending, while ex-member Charles Goodhart countered the argument and expects the central bank to pause or scale back its emergency program over the remainder of the year as governments around the globe begin to tighten policy. At the same time, Credit Suisse overnight index swaps are up 95bp in November from 85bp in the previous week, and long-term expectations for higher borrowing costs in the U.K. may continue to support the rebound in the British pound if the central bank votes unanimously to maintain its current policy in place.

Trading the given event risk favors a bearish outlook for Cable as market participant anticipate the BoE to expand policy this month but nevertheless, the central bank may adopt a wait-and-see approach this month as policy makers see the economy emerging from the worst recession since the post-war period. Therefore, if the MPC holds borrowing costs at the record-low and maintains its GBP 175B asset purchase program, we will look for a green, five-minute candle following the rate decision 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 taking market volatility into account, 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 cost once the first position reaches its target in order to lock-in our profits.

In contrast, the downturn in the labor market paired with the instability in the financial system may lead the central bank to take additional steps in an effort to encourage bank lending, and price action following an expansion in monetary policy could set the stage for a short GBP/USD trade as the BoE sees a risk for a protracted recovery. As a result if the MPC increases the scope of the AFP by GBP50B to GBP 225B this month, we will favor a bearish outlook 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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