GBP/USD: Trading the U.K. Consumer Price Report

Trading the News: U.K. Consumer Price Index

What’s Expected
Time of release:        12/15/2009 09:30 GMT, 04:30 EST
Primary Pair Impact :    GBPUSD
Expected:         1.8%
Previous:         1.5%

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

October  2009 U.K. Consumer Price Index

Inflation in the U.K. surged more-than-expected as consumer prices advanced for the first time in eight months amid rising costs in fuel and air fares, leading the headline reading to soar 1.5% from a year earlier, compared with 1.1% in the month prior. Meanwhile, Bank of England board member Andrew Sentance held a hawkish view and stated there may be “volatility” in price growth over the near-term following the rise in commodity prices, but expects price pressures to hold below the 2% until 2011, and went on to say it is still too early  to consider tightening monetary policy especially after the central bank decided to expand it bond-purchase plan to 200 billion pounds ($336 billion) in order to stem the downside risks for growth and inflation. Moreover, there is likely to be some upward pressure on inflation as the economy stabilizes, Sentance added.

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.

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 price in the U.K. are anticipated to rise 0.2% in November, with economists forecast the annual rate of inflation to expand 1.8% from the previous year after rising 1.5% in the prior month, and the rebound in price growth may drive the British Pound higher as policy makers hold an improved outlook for future growth. 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. A report by the British Retail Consortium showed shop price in the U.K. expanded at an annualized pace of 0.2% in November after holding flat in the previous month, led by a 2.8% rise in the cost of food, while producer prices increased 2.9% from the previous year to mark the highest rate of growth since February 2009. In addition, 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,” and 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. At the same time, Chancellor of the Exchequer Alistair Darling said that he sees the economy returning 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 expects inflation to grow 1.5%-3.0% by early next year as a result of rising energy costs. Meanwhile, the BoE held the benchmark interest rate at the record-low earlier this week and maintained its GBP 200B asset purchase program in order to encourage a sustainable recovery, and went onto say that it will take an additional two-months to complete the emergency measures. Moreover, the central bank pledged to keep the AFP under review as policy makers see the economy emerging from the worst-recession since the post-war period, and Governor Mervyn King may hold an enhanced outlook for the region as growth prospects improve.
 
Trading the given even risk favors a bullish outlook for the British Pound as market participants expect prices pressures to intensify in November, and price action following the release could set the stage for a long pound-dollar trade. Therefore, if the headline reading for inflation expands 1.8% or greater from the previous year, we will need to see a green, five-minute candle subsequent to the event to establish a buy entry on two-lots of GBP/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance taking volatility into account, and this risk will establish 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 the target in order to lock-in our profits.

On the other hand, tightening credit conditions paired with the rise in employment may hamper price pressures as economic activity remains weak, and a dismal inflation report could weigh on the exchange rate as investors weigh the outlook for future policy. As a result, if consumer prices expand at an annual pace of 1.5% or less, we will favor a bearish outlook for Cable, and will follow the same set up 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