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

Trading the News: U.K. Consumer Price Index

What’s Expected
Time of release:        11/17/2009 09:30 GMT, 04:30 EST
Primary Pair Impact :    GBPUSD
Expected:         1.4%
Previous:         1.1%

Effects the U.K. Consumer Price Index has had over GBPUSD for the past 2 months

September 2009 U.K. Consumer Price Index

Price pressures in the U.K. unexpectedly held flat in September, with the headline reading for inflation slipping to 1.1% from 1.6% in the previous month, and the larger-than-expected drop in the CPI may lead the Bank of England to hold borrowing costs at the record-low going into the following year in an effort to balance the risks for the economy. The breakdown of the report showed food prices slumped 0.7% from August, with travel costs tumbling 7.6% during the month, while prices for clothing and footwear surged 3.6% after rising 1.4% in the month prior. Despite the downturn in price growth, the BoE held a hawkish outlook at its policy meeting this month and said that “inflation would probably be higher in the short-term” than initially forecasted, and went onto say price pressures are likely to be “extremely volatile” over the medium-term as the government takes unprecedented steps to shore up the economy.

August 2009 Consumer Price Index

Consumer prices in the U.K. increased 0.4% in August, leading the annual rate of inflation to expand 1.6% from the previous year amid expectations for a 1.4% rise, while the core CPI held steady at 1.8% for the second consecutive month. A deeper look at the report showed travel costs jumped 2.7% from July on the back of higher energy prices, with the cost of clothing and footwear advancing 1.4%, while food prices slumped 0.6% to mark the biggest decline since 2000. The data reinforces an improved outlook for the economy as policy makers take unprecedented steps to stem the downside risks for growth and inflation, and suggests that the region may have avoided deflation as the Bank of England holds the benchmark interest rate at the record-low and commits GBP 175B in asset purchases in order  to steer the nation out of 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 rise 0.1% in October, with economists forecasting the annual rate of inflation to grow 1.4% after rising 1.1% in the previous month, and the rebound in price growth could drive the British pound higher as investors weigh the outlook for future policy. 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 the slack in economic activity may continue to weigh down on price growth as the economy fails to emerge from the worst recession since the post-war period. Furthermore, retail spending held flat in September versus forecasts for a 0.5% rise, with service-based activity unexpectedly slipping 0.1% during the three-months through August, while the National Institute of Economic and Social Research held a weakened outlook for the region and said economic activity contracted 0.4% during the three-months through October. In addition, a report by the Bank of England showed consumer credit weakened for the third month in September, while the central bank held an “open mind” to ease policy further at its quarterly inflation report in order to balance the risks for the economy, and the slump in price growth may lead the BoE to take additional steps to stimulate the economy as Governor Mervyn King expects “the persistent margin of spare capacity” within the region to weigh down on price pressures for “some time to come.” The BoE held the benchmark interest rate at 0.50% earlier this month and increased its asset purchase program to GBP 200B from GBP 175B in the previous month amid forecasts for an expansion to GBP 225B, but held a hawkish outlook for inflation, stating that higher oil prices paired with the value-added-tax (VAT) could lead price pressures to rise “sharply” over the near-term. Moreover, the MPC said that the rebound in growth will soon become evident as the expansion in monetary and fiscal policy works its way through the real economic, and noted that the depreciation in the exchange rate could help to fan inflation over the coming months. Meanwhile, former BoE dove David Blanchflower argued that the central bank should expand its emergency programs further in an effort to stem the downside risks for growth and inflation, and expectations for further easing is likely to drag on the British pound as investors weigh the outlook for future policy. Nevertheless, as risk trends continue to drive the foreign exchange market, a rise in risk aversion could weigh on Cable as investors lower their temperament for higher-yielding currencies.

Trading the given event risk favors a bullish outlook for Cable as economists project the headline reading for inflation to improve in October, and price action following the release could set the stage for a long pound-dollar trade. Therefore, if consumer prices grow at an annual rate of 1.4% or higher, we will look for a green, five-minute candle subsequent to the event 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 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 lock-in our profits.

In contrast, the slump in the labor market paired with downturn in private spending is likely to weigh on price growth as the economy fails to emerge from the recession in the third quarter, and a dismal CPI reading is likely to stoke increased selling pressures on Cable as investors speculate the Bank of England to ease policy further going forward. As a result, if consumer prices grow at an annual rate of 0.8% or less, we will favor a bearish outlook for the U.K. currency, and will follow the same setup for a short pound-dollar trade as the long position laid out above, just in reverse.

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