GBP/USD: Trading the U.K. Advanced 4Q GDP Report

Trading the News: U.K. Gross Domestic Product

What’s Expected
Time of release:        01/26/2009 09:30 GMT, 04:30 EST
Primary Pair Impact :    GBPUSD
Expected:         0.4%
Previous:         -0.2%

Effects the U.K. Gross Domestic Product has had over GBPUSD for the past 2 quarters

3Q 2009 U.K. Gross Domestic Product

U.K.’s gross domestic product unexpectedly slipped 0.4% in the third quarter after contracting 0.6% during the three-months through June amid expectations for a 0.2% expansion in the growth rate. At the same time, economic activity slumped at an annual pace of 5.2%, which exceeded expectations for a 4.6% drop in the growth rate as services, manufacturing and construction kept the economy mired in its longest recession on record. Looking at the breakdown of the report, the most notable decline was a 0.2% contraction in service-based activity, which account for more than two-thirds of the economy, and the data suggests that Britain may turn out to be one of the lasts countries amongst the G7 to exit its recession, which was sparked by the worst financial crisis since the post-war period. As a result, the Bank of England is widely anticipated to maintain its currency policy over the near-term in order to support the real economy.

2Q 2009 U.K. Gross Domestic Product

Economic activity in the U.K. weakened more than expected during the second quarter, with the advanced GDP reading falling 0.8% from the first three-months of the year amid forecasts for a 0.3% contraction. The breakdown of the report showed construction outputs plunged at an annual rate of 14.7% to mark the biggest decline since comparable records began in 1948, with service-based activity weakening 4.4% from the previous year, and conditions may continue to get worse throughout the second-half of the year as households face a weakening labor market paired with tightening credit conditions. Nevertheless, Bank of England board member Andrew Sentance expects economic activity to pick up towards the end of the year as policy makers take unprecedented steps to steer economy out of recession, and the central bank may ease policy further over the coming months in order to stem the risks for growth and inflation.

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 widely expected to face increased volatility over the next 24 hours of trading as economists anticipate the nation to emerge from its worst recession since the post-war period and forecast growth rate to expand 0.4% in the fourth quarter after unexpectedly contracting 0.2% during the three-months through September. At the same time, the National Institute of Economic and Social Research said the United Kingdom emerged from the recession during the last three-months of 2009 and forecasts the growth rate to expand 0.3% from the third quarter, and said that a “recovery is starting to emerge” as the expansion in monetary and fiscal policy continues to feed through the real economy. In addition, a report by the Office for National Statistics showed claims of unemployment benefits slipped 15.2K in December to mark the biggest drop since December, while the jobless rate under the International Labor Organization’s standards unexpectedly weakened to 7.8% during the three-months through November from 7.9% in the previous period. Moreover, mortgage approvals in the U.K. increased to an annual pace of 60.5K in November, which is the highest reading since March 2008, while service-based activity expanded for the eighth consecutive month in December, and conditions are likely to improve going forward as policy makers continue to shore up the real economy. The Bank of England vote unanimously to hold the benchmark interest at the record-low of 0.50% earlier this month and maintained its GBP 200B asset purchase program in order to encourage a sustainable recovery, but went onto say that the scale of the emergency program will remain under review as policy makers aim to balance the risks for growth and inflation. However, the central bank noted that the economy faces “powerful headwinds” as policy makers continued to see a risk for a protracted recovery, and argued that a “significant fiscal consolidation was needed in the United Kingdom” as the BoE aims to normalize policy this year. Meanwhile, board member Andrew Sentence said that the central bank should halt its GBP 200B plan during an interview with the Guardian newspaper and assess the risks for inflation as policy makers anticipate price pressures to exceed the 2% target in the short-run. In addition, Mr. Sentence noted that the central bank could adopt a ‘wait and see’ approach as the “recovery gathers momentum,” but went onto say that the “early phase” of the recovery could feel “fragile and uncertain” as households continue to face fading demands for employment paired with tightening credit standards.

Trading the given event risk favors a bullish outlook for the British Pound as market participants anticipate the U.K. to emerge from the recession in the fourth-quarter, and price action following the release could set the stage for a long Cable trade as policy makers see the nation returning to growth. Therefore, if the growth rate expands 0.4% or greater from the previous three-month period, we will need to see a green, five-minute candle subsequent to the release to generate 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 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 an effort to preserve our profits.

On the other hand, the slump in global trade paired with the deterioration in the labor market may continue to weigh on the overall economy, and a dismal GDP report could drag on the exchange as investors mull over the prospects for a sustainable recovery. As a result, if the growth rate expands 0.2% or less, we will favor a bearish outlook for Cable, 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