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:        12/18/2009 09:30 GMT, 04:30 EST
Primary Pair Impact :    GBPUSD
Expected:         23.0B
Previous:         11.4B

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

October 2009 U.K. Public Sector Net Borrowing

The budget deficit in the U.K. for the month of October rose to its highest level since record keeping began in 1993 as the recession weighed on tax revenues. Public sector net borrowing jumped GBP 11.4B after rising GBP 0.1B in the previous year, which exceeded economists’ expectations for a GBP 7.0B rise, the office for National Statistics said in London. At the same, a measure of the cash entering and leaving the Treasury showed the deficit widened to 5.9 billion pounds in October as compared to a 2.5 billion-pound surplus a year earlier, while net debt advanced to 829.7 billion pounds , marking the highest level since at least 1974.  Meanwhile, a treasury spokesman said the figures are in line with forecasts made at the annual budget statement in April, which reflects the loss of tax receipts and the rise in government spending.

September  2009 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.

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 going into the end of the week as economists forecast public sector borrowing in the U.K. to increase GBP 23.B in November, which would be the largest short-fall since comparable records began in 1993, and the data could weigh on the exchange rate as the government takes unprecedented steps to stimulate the ailing economy. Fitch Ratings said that the U.K. needs “the largest budget adjustment” amongst the top rated countries in order to maintain its AAA sovereign credit range, but stated that the outlook for the economy remains “stable” as the firm expects the government “will articulate a strong fiscal consolidation program next year.” Moreover, Moody’s Investor Services announced that the U.K. could “test the Aaa boundaries” as public finances continue to deteriorate, while Standard and Poor’s lowered its outlook for Great Britain to ‘negative’ from ‘stable’ back in May as the group expects the public debt to approach 100% of GDP “and remain near that level in the medium term.” Nevertheless, Bank of England Governor Mervyn King said that he does not see “any immediate risk” for the nation’s credit rating and went onto say that there wasn’t “any impediment” for the government to implement a credit plan and reduce the deficit as policy makers see the economy emerging from the worst recession since the post-war period. At the same time, the Debt Management Office said the agency is “not unduly concerned” about the nation’s credit rating after raising planned gilt sales by GBP 5.1B to a record high of GBP 225.1B for the fiscal year ending in March 2010, and expects “continued structural demand” for government bonds as the “U.K. has access to deep and liquid debt markets.” In addition, Chancellor of the Exchequer Alistair Darling pledged to make a greater effort to temper the rise in public borrowing as growth prospects improve, but repeated that the government will continue to support the economy as policy makers aim to encourage a sustainable recovery. Furthermore, Mr. Darling said that it will be critically important for the government to lower the deficit as the recovery takes place, and noted that economic growth is the best way to reduce the rate of public borrowing as policy makers continue to shore up the real economy.

Trading the given event risk favors a bearish outlook for Cable as the markets expect the government deficit to rise at a record pace in November but nevertheless, as policy makers see the economy emerging from the recession, price action following an enhanced report could set the stage for a long pound-dollar trade. Therefore, if public borrowing rises GBP 18.0B or less from the previous month, we will keep an eye out 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 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. The 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 preserve our profits.

On the other hand, the slump in tax revenues paired with the expansion in fiscal policy is likely to weigh on public finances, and a record rise in government borrowing is likely to weigh on the exchange rate as investors weigh the outlook for future growth. As a result, if public borrowing jumps GBP 23.0B or higher 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