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:        02/04/2010 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

January 2010 Bank of England Interest Rate Decision

The Bank of England vowed to spend the rest of its 200 billion-pound ($318 billion)  bond purchase program, while also keeping its key benchmark interest rate at its current low of 0.50% in January as policy makers aim to cement the economy’s escape from the recession. Meanwhile, Finance Minister Alistair Darling suggested that economic growth may have now resumed, while signaling that the momentum is building in manufacturing and services. Looking ahead,  the central bank is expected to have new growth and inflation forecasts at its meeting on February 4th as the Bank of England’s task in steering the economy back to growth is being complicated by uncertainty concerning how the government is seeking to sought out the budget deficit, and growth expected to recover at a subdued pace.

December  2009 Bank of England Interest Rate Decision

The Bank of England maintained its 200 billion pound asset purchase program, while also keeping its bank rate at a record low of 0.50% in December to shore up the real economy, and central bank is likely to a dovish outlook going forward as policy makers continue to see a risk for a protracted recovery. At the same time, Chancellor of the Exchequer Alistair Darling pledged to provide support for the economy until a recovery is evident and secured, and added that the most “natural” time to assess the bond program again will be in February, when the BoE is scheduled to release its quarterly inflation report. Meanwhile, Mr. Darling remained committed to increase income taxes as the recession drives up U.K. government borrowing, while public spending “will be much, much tighter,” he added.

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 maintain the benchmark interest rate at 0.50% this month, while market participants speculate the central bank to conclude its easing cycle as the economy emerges from its worst recession since the post-war period. A Bloomberg News survey shows 50 of the 51 economists polled forecast the MPC to keep its asset purchase target at GBP 200B and suspended its emergency program as policy makers assess the impact of the APF, while investors are pricing a zero percent chance for a rate hike as the central bank aims to encourage a sustainable recovery. The advanced 4Q GDP report showed economic activity expanded 0.1% from the last three-months of 2009, which fell short of expectations for a 0.4% rise in the growth rate, while mortgage approvals unexpectedly declined to an annual pace of 59.0K in December from a revised 60.0K in the previous month to mark the first contraction in over a year. At the same time, a separate report showed claims for unemployment benefits slipped 15.2K during the same period, which was the biggest decline since April 2007, and conditions are likely to improve going forward as the expansion in monetary and fiscal policy continues to feed through the real economy.

Nevertheless, after voting unanimously to maintain its current policy in January, the BoE announced it completed its planned purchases of Gilts and said that the board will “review whether the sale of the asset purchase program should be changed” at its next meeting, “alongside its latest inflation projections.” In addition, the central bank halted its swap lines with the Federal Reserve during the previous month as financial conditions improve, and the MPC is likely to normalize policy this year as the committee aims to balance the risks for growth and inflation. Consumer prices in the U.K. jumped at an annual pace of 2.9% in December to top forecasts for a rise to 2.6%, and mounting price pressures would lead Governor Mervyn King to write a letter to Chancellor of the Exchequer Alistair Darling as policy makers see a risk for price growth to exceed the upper bounds for inflation. Meanwhile, board member Andrew Sentence expects the economic to avoid a ‘double-dip recession’ and sees scope for the BoE to adopt a ‘wait-and-see’ approach as the economic “recovery gathers momentum.”

Trading the given event risk may not be as clear cut as some of our previous trades, but as market participants speculate the BoE to conclude its easing cycle this month, a rise in interest rate expectations could drive the British Pound higher. Therefore, if the central bank keeps the asset purchase target at GBP 200B and holds a hawkish outlook for future policy, we will need to see a green, five-minute candle following the rate decision to generate a buy entry on two-lots of GBP/USD. Once these conditions are fulfilled, 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. The second objective will be based on discretion, and we will move the stop on the second to cost once the first trade hits its mark in an effort to preserve our profits.

On the other hand, the ongoing weakness in private spending paired with tightening credit conditions may lead the central bank to hold a cautious outlook for the economy, and the MPC may opt to extend their emergency program in order to stem the downside risks for growth. As a result, if the BoE raises its asset purchase target or holds a dovish outlook for future policy, 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