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

Trading the News: Bank of England Interest Rate Decision

What’s Expected
Time of release:        12/10/2009 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

November 2009 Bank of England Interest Rate Decision

The U.K. central bank held borrowing costs at 0.50% in November and increased its asset purchase program to GBP 200B from GBP 175B in the previous month to encourage a sustainable recovery, and conditions are likely to improve going forward as the expansion in monetary and fiscal policy feeds through the real economy. The Bank of England meeting minutes showed David Miles voted to expand the emergency program by GBP 40B, with Chief Economist Spencer Dale pushing to keep the AFP unchanged at GBP 175B, but at the same time, the MPC discusses the possibility of lowering the deposit rate for commercial bank reserves in an effort to encourage lending. Meanwhile, BoE Governor Mervyn King reiterated that the central bank will maintain an “open mind” for future policy going forward as policy makers continue to see a risk for a protracted recovery.

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.

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 Bank of England is widely expected to hold the benchmark interest rate at 0.50% in December and maintain its GBP 200B asset purchase program in an effort to encourage a sustainable recovery, and the central bank may hold an improved outlook for future growth as policy makers see the economy emerging from the worst recession since the post-war period. A Bloomberg survey shows all of the 53 economists polled forecast the central bank to maintain its current policy going into the following year, while investors are pricing a zero percent chance for a rate hike according to Credit Suisse overnight index swaps as policy makers aim to stem the downside risks for growth and inflation. Nevertheless, the preliminary GDP report showed economic activity contracted 0.3% in the third quarter amid an initial forecasts for a 0.4% drop in the growth rate, while the National Institute of Economic and Social Research GDP estimate increased 0.2% in November to mark the first positive reading since May 2008, and conditions are likely to improve going into the following year as the expansion in monetary and fiscal policy continues to feed through the real economy. Moreover, consumer prices in the U.K. increased at an annual pace of 1.5% in October from 1.1% in the previous month, with the core rate of inflation rising to 1.8% from 1.7% in September, while mortgage approvals rose 57.3K during the same period to mark the biggest increase since March 2008. Meanwhile, Bank of England Chief Economist Spencer Dale held a hawkish outlook for inflation and said that the expansion in the asset purchase program paired with record-low interest rates “increases the likelihood that asset prices may move out of line with their fundamental values,” but went onto say that economic activity has “begun to stabilize” and sees the nation “moving into a period of renewed expansion” as policy makers take unprecedented steps to stimulate the ailing economy. In addition, Chancellor of the Exchequer Alistair Darling said that he expects the economy to return to growth going into the following year during the pre-budget report and forecasts economic activity to expand at an annual rate of 1.0%-1.5% in 2010, and sees inflation rising 1.5%-3.0% by early next year, led by rising energy costs. However, as central bank Governor Mervyn King maintains an “open mind” for future policy and sees a risk for a protracted recovery, the MPC may expand its emergency program over the coming months as board members see the downside risks for the economy are “somewhat greater than implied by the inflation report projections.”

Trading the BoE rate decision may not be as clear cut as some of our previous trades as market participants anticipate the central bank it maintain its current policy in December but nevertheless, price action following the rate decision could set the stage for a long Cable trade as policy makers see the economy emerging from the recession. Therefore, if the MPC holds an improved forecast for growth and inflation paired with a hawkish outlook for future policy, 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 look to set the initial stop at the nearby swing low or a reasonable distance, and this risk will determine our first objective. Our second target 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.

On the other hand, the ongoing slump in the labor market paired with fears of a protracted recovery may lead the central bank to hold a weakened outlook for the economy, and dovish rhetoric following the policy meeting is likely to drag on the exchange rate as investors weigh the prospects for future policy. As a result, if the BoE maintains an “open mind” for its emergency programs and talks down expectations for a rate hike, we will favor a bearish outlook for the Sterling, and will follow the same strategy for a short pound-dollar trade as the long position laid out above, just in reverse.

Questions? Comments? Join us in the DailyFX Forum

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