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

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

What’s Expected
Time of release:        11/19/2009 09:30 GMT, 04:30 EST
Primary Pair Impact :    GBPUSD
Expected:         7.0B
Previous:         14.8B

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

September 2009 U.K. Public Sector Net Borrowing

The budget deficit in the U.K. rose at a record-pace in September, with the short-fall increasing GBP 14.8B amid expectations for a GBP 15.5B rise as government revenues tumbled at an annual pace of 6.3% from the previous year. Nevertheless, as households face fading demands for employment paired with the subdued wage growth, the deficit is expected to push higher going forward, and the government may look to increase taxes over the following year as policy makers pledge to restore public finances. Meanwhile, the Bank of England held the benchmark interest rate at the record-low and maintains its GBP 175B asset purchase program in an effort to stimulate the ailing economy, and the central bank may continue to ease policy further over the coming months to encourage a sustainable recovery within the region.

August 2009 Public Sector Net Borrowing

Public borrowing in the U.K. increased GBP 16.1B in August amid expectations for a GBP 17.6B rise, and the data encourages an enhanced outlook for long-term growth as policy makers pledges to balance the budget following the surge in government spending. However, as households face a weakening labor market paired with the slump in wage growth, the slump in tax revenues could limit the scope for the U.K. government to normalize public finances, and the Bank of England may take additional steps to stem the downside risks for growth and inflation as policy makers see a risk for a protracted recovery. Nevertheless, a document from the HM Treasury showed that the public sector net cash requirement will reach GBP 179.8B in the fiscal year through March 2011, and the conditions may get worse as policy makers take unprecedented steps 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

The British Pound is likely to face increased volatility over the next 24 hours of trading as economists forecast public sector borrowing in the U.K. to increase GBP 7.0B in October, and the rise in the government deficit could weigh on the outlook for future growth as policy makers take unprecedented steps to stem the downside risks for growth and inflation. The advanced GDP reading showed economic activity unexpectedly contracted 0.4% in the third quarter, with the annual rate of growth slipping 5.2% from the previous year, while the National Institute of Economic and Social Research held a weakened outlook for the region and said the growth rate contracted 0.4% during the three-months through October. In addition, retail spending held flat in September versus forecasts for a 0.5% rise, while the Nationwide consumer confidence index held steady at 72 in October as the gauge for future expectations pulled back to 106 from 108 in the previous month, and fading demands for employment paired with the slump in wage growth may continue to weigh on household sentiment as policy makers see a risk for a protracted recovery. Moreover, Fitch Ratings held a cautious outlook for nation’s AAA sovereign credit rating and said that the U.K. needs “the largest budget adjustment” amongst the industrialized countries earlier this month, while Standard & Poor’s said the nation could lose its credit rating in May as the firm sees a risk for public debt to reach 100% of GDP by 2013. Meanwhile, the Bank of England 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 in an effort to stem the risks for a protracted recovery, 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, but saw a “substantial margin” of spare capacity throughout the region as businesses continue to keep a lid on production and employment. At the same time, the minutes of the policy meeting showed that the MPC voted 7-1-1 as board member Spencer Dale dissented to keep the AFP at GBP 175B, while David Miles pushed to raise the AFP by GBP 40B in order to “provide greater insurance against the downside risks to growth and inflation arising from constrained credit supply.” As the central bank remains split on the economic outlook, with Governor Mervyn King maintaining an “open mind” for future policy, the BoE may continue to ease policy further over the coming months as members of the MPC see the downside risks for the economy are “somewhat greater than implied by the inflation report projections.”

Trading the given event risk favors a bearish outlook for Cable as market participants anticipate the public deficit to rise further going into the following but nevertheless, the less-than-expected rise during the last two months has left the door open of an enhanced report. Therefore, if public borrowing increases GBP 4.0B or less in October, we will need to see 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 the initial stop at the nearby swing low or a reasonable distance taking 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 breakeven once the first trade reaches its target in order to preserve our profit.

In contrast, the slump in tax revenues paired with the expansion in fiscal policy is likely to weigh on public finances, and price action following a larger-than-expected rise in the government deficit could set the stage for a short Cable trade. As a result, if public borrowing increases GBP 7.0B or greater from the previous month, we will favor a bearish outlook for the U.K. currency, and will follow the same strategy 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