GBP/USD: Trading the Change in U.K. Mortgage Approvals

Why Is This Event Important:

As bank lending in the U.K. is expected to weaken in June, the data is likely to reinforce a weakened outlook for future growth, which could spur a reversal in the British Pound as investors weigh the prospects for a sustainable recovery. However, consumer credit is forecasted to increase another GBP 0.2B during the same period after expanding GBP 0.3B in May, and the mixed batch of economic releases could fail to produce a clear directional bias and spark choppy price action.

What’s Expected:

Time of release:07/29/2010 8:30 GMT, 4:30 ESTPrimary Pair Impact :GBPUSD

Expected: 48.8K

Previous: 49.8K

Will This Be Market Moving (Scenarios):

Mortgage approvals in Britain are forecasted to increase at a slower pace in June, with market participants projecting commercial banks to grant 48.8K in home loans from 49.8K in the previous month, and the ongoing weakness in the European banking system could drag on the recovery as households face tightening credit conditions paired with the deterioration in the labor market. As a result, the Bank of England is widely expected to hold the benchmark interest rate at 0.50% and maintain its asset purchased target at GBP next month, but MPC board member Andrew Sentance may continue to dissent against the majority as price growth holds above the 3% limit.

The Upside

The advanced 2Q GDP report showed economic activity expanded at the fastest pace in four-years, with construction marking the biggest rise since 1963, and banks may increasing their willingness to lend as the recovery gathers pace. As economic conditions improve, the BoE may increase its willingness to normalize policy going into the following year, and the central bank may look to switch gears over the coming months in an effort to balance the risks for growth and inflation.

The Downside

Nevertheless, a report by the British Bankers’ Association showed loans for home purchases grew only 34.8K in June after expanding a revised 36.4K in the previous month to mark the slowest pace of growth since February, and lending in the U.K. may weaken further over the coming months as banks continue to clean up their balance sheets. As a result, the central bank is likely to support the real economy going forward, and may see scope to expand policy further over the coming months as the outlook for future growth remains clouded with uncertainties.

How To Trade This Event Risk

Expectations for a pullback in bank lending certainly favors a bearish outlook for the British Pound but nevertheless, an unexpected rise in mortgage approvals could spark a bullish reaction in the sterling as the outlook for future growth improves. Therefore, if banks grant 51.0K loans or greater in June, we will need to see a green, five-minute candle following the release to generate 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 market 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 cost once the first trade reaches its mark in order to preserve our profits.

On the other hand, the instability in the European financial system paired with the tightening in fiscal policy could lead commercial banks to scale back on lending, and a dismal report could lead Cable to retrace the advance from earlier this week as the outlook for future growth falters. As a result, if mortgage approvals grow 48.8K or less from the previous month, we will favor a bearish outlook for the sterling, and will utilize the same strategy for a short pound-dollar trade as the long position revealed above, just in reverse.BoE To Shift Gears - Stronger Than ExpectationsEconomic Outlook Weakens –Lower Than Expectations

Bank lending deteriorates, pushing the central bank to maintain a loose policy stance throughout the 2010.

An unexpected rise in mortgage lending could lead the BoE to raise its assessment for the real economy.

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

May 2010 U.K. Mortgage Approvals

Mortgage approvals in the U.K. unexpectedly held flat at 49.8K in May versus expectations for a 51.0K rise, while consumer credit increased GBP 0.3B during the same period, which exceeded forecasts for a GBP 0.1B advance, and the data reinforces a mixed outlook for the region as policy makers maintain a cautious bias for future growth. As the households continue to face tightening credit conditions paired with the ongoing weakness in the labor market, the Bank of England is widely expected to maintain a loose policy over the coming months, and the central bank may hold a dovish outlook for future policy as the new coalition in the U.K. plans to withdraw public support and target the budget deficit. However, BoE board member Andrew Sentance dissented against the majority and voted to increase the benchmark interest rate by 25bp as inflation holds above the government’s 3% limit, and the central bank may look to switch gears over the coming months in order to balance the risks for the economy.

Bullish price action following the release would have left us without a trade.

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