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:        03/04/2010 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

February 2010 Bank of England Interest Rate Decision

The BoE suspended its GBP 200B asset purchase program in February, while holding the benchmark interest rate at 0.50% as the central bank aims to balance the risks for growth and inflation.  The minutes of the meeting showed the MPC voted unanimously to maintain their current policy as “the arguments were very finely balanced,” and pledged to “provide further monetary stimulus” if conditions warrant as they continue to see a risk for a protracted recovery. At the same time, central bank governor Mervyn King held a dovish outlook for price growth and said “the latest inflation report forecast suggests that the underlying pressures are to the downside,” and said the MPC will take “whatever actions are necessary” to balance the risks for the economy.

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.

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 anticipated to hold the benchmark interest rate at 0.50% in March and maintain the option to increase the scope of its asset purchase program as policy makers continue to see a risk for a protracted recovery. A Bloomberg News survey shows all of the 45 economists polled forecast the central bank to keep its asset purchase target at GBP 200B, while investors a pricing a zero percent chance for a rate hike this month according to Credit Suisse overnight index swaps. The preliminary 4Q GDP reading showed the growth rate expanded 0.3% from the previous three-month period amid an advanced forecast for a 0.4% rise, led by a 3.3% drop in business investments, while a 1.2% jump in government spending held to counteract the ongoing weakness in the private sector. Moreover, a report by the National Statistics Office showed retail spending tumbled 1.2% from December, which exceeded forecasts for a 0.5% decline, while claims for jobless benefits unexpectedly increased 23.5K during the same period as businesses kept a lid on production and employment.

At the same time, the BoE held a dovish tone in its quarter inflation report and said that the recovery was “somewhat weaker” than previous expected, with the ongoing slack in the economy continuing to weigh on the outlook for future growth. As a result, the central bank anticipates to see a moderate recovery this year and projects GDP to increase 1.4% in 2010 amid an initial forecasts for a 2.2% expansion in the growth rate. Moreover, BoE Governor Mervyn King reiterated that he continues to see a “substantial margin” of slack in his letter to Chancellor of the Exchequer Alistair Darling, and went onto say subdued wage growth would continue to drag on GDP and inflation as private-sector spending remains one of the leading drivers of growth. As a result, the central bank is likely to maintain a dovish stance at its meeting this week, and the MPC may see scope to further expand its emergency program over the coming months as policy makers aim to encourage a sustainable recovery.

Trading the given event risk may not be as clear cut as some of our previous trades as the BoE is expected to keep the interest rate and the emergency program on hold, but commentary following the rate decision could spark volatility in the exchange rate as investors weigh the prospects for future policy. Therefore, if the central bank drops its dovish tone and holds an improved outlook for growth and inflation, we would need to see a green, five-minute candle following the rate decision 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 market volatility into account, and this risk will generate our first target. The 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 order to preserve our profits.

In contrast, the ongoing weakness in the labor market paired with the slump in the private sector may lead the MPC to hold a dovish policy stance over the coming months, and speculation for further easing is likely to weigh on the exchange rate as the central bank continues to see a risk for a protracted recovery. As a result, if the MPC sees scope to expand its emergency program during the first-half of the year, 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