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

Trading the News: U.K. Consumer Prices

Why Is This Event Important:

However, central bank board member Andrew Sentance may continue to dissent against the majority and make another push for a rate hike as price growth holds above the 3% limit for inflation, and the stickiness in consumer prices could lead the BoE to shift gears and normalize policy over the coming months as it aims to balance the risks for the region. 

What’s Expected:
Time of release:        07/13/2010 8:30 GMT, 4:30 EST
Primary Pair Impact :    GBPUSD
Expected:         3.1%
Previous:         3.4%

Will This Be Market Moving (Scenarios):

Consumer prices in the U.K. are forecasted to grow at an annual pace of 3.1% in June after expanding 3.4% in the previous month, while the core rate of inflation is projected to fall back to 2.8% from 2.9%, which would be the slowest pace of growth since December. However, as price growth holds above the 3% upper limit for inflation, policy makers may turn their attention to the stickiness in consumer prices as they maintain their dual mandate to ensure price stability while promoting full employment.

The Upside

As businesses in Britain raise their rate of production, firms may increase their willingness to pass on higher costs onto consumers, and an unexpected expansion in price growth could stoke speculation for a rate hike later this year as the rebound in economic activity gathers pace. As a result, the BoE may drop its dovish outlook and see scope to lift the benchmark interest rate off the record-low over the coming months in order to mitigate the risks for inflation.

The Downside

Producer prices in the U.K. unexpectedly contracted for the first time in June, with the annualized rate slipping to a three-month low of 5.1%, and the slack within the real economy could trigger a lower-than-expected inflation reading, which could spark a sell-off in the British Pound as investors weigh the prospects for future policy. As BoE Governor Mervyn King expects inflation to fall back towards the 2% target by the end of the year, the central bank may look to support the economy throughout 2010 as policy makers aim to foster a sustainable recovery.

How To Trade This Event Risk 

Expectations for a slower pace of price growth favors a bearish outlook for the British Pound but nevertheless, price pressures may push higher in June, which could set the stage for a long Cable trade. Therefore, if the headline reading for inflation grows at an annualized pace of 3.4% or higher, we will need to see a green, five-minute candle following the release to establish a buy entry on two-lots of GBP/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance after taking 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 in an effort to lock-in our profits.

At the same time, the drop in producer prices paired with the ongoing weakness in the real economy may lead to a larger-than-expected drop in price growth, and weaker inflation would certainly give the BoE scope to maintain a loose policy stance throughout 2010 as it aims to balance the risks for the region. As a result, if consumer prices slip to 3.1% or lower in June, we will favor a bearish outlook for the sterling, and will implement the same strategy for a short pound-dollar trade as the long position laid out above, just in reverse.

Impact that the U.K. CPI has had on GBP during the last month

May 2010 U.K. Consumer Price Index

Consumer prices in the U.K. expanded 0.2% in May, which fell short of expectations for a 0.4% rise, while the annualize rate slipped to 3.4% from 3.7% in the previous month to mark the first decline in three-months. A deeper look at the report showed the core rate of inflation pulled back to 2.9% from 3.1% in April, which was largely in-line with expectations, and price pressures may continue to deteriorate over the coming months as the ongoing slack within the real economy weighs on price growth. The breakdown of the report showed transportation costs increased 1.9% to lead the advance, with the cost of housing advancing 1.1%, while prices for food, alcohol and tobacco slipped 0.1% after expanding 0.8% in April. As inflation tapers off, the BoE may see scope to hold a dovish policy stance over the coming months, but board member Andrew Sentance may continue to dissent against the majority and push for a rate hike as price growth holds above the 3% limit.

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.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com