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GBP/USD: Trading the Bank of England Interest Rate Decision

By , Currency Analyst
08 September 2010 19:35 GMT

Trading the News: Bank of England Interest Rate Decision

Why Is This Event Important:

As the central bank anticipates the ongoing slack within the real economy to bear down on inflation, the MPC may see scope to sustain monetary support throughout the remainder of the year. However, a shift in the central bank’s economic assessment paired with hawkish commentary could lead to a breakout in the GBP/USD as it maintains the narrow range carried over from the previous month.

What’s Expected:

Time of release:09/09/2010 11:00 GMT, 7:00 EST

Primary Pair Impact :GBPUSD

Expected: 0.50%

Previous: 0.50%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows all of the 31 economists polled forecast the BoE to hold the benchmark interest rate at 0.50% and maintain the asset purchase target at GBP 200B, while investors are pricing a 4% chance for a 25bp rate hike according to Credit Suisse overnight index swaps. At the same time, the central bank may refrain from releasing a policy statement like we’ve seen over the past few months, which would lead to a muted reaction in the exchange rate.

The Upside

The preliminary 2Q GDP showed economic activity expanded at a faster pace than initial expected, with household spending exceeding forecasts, and the central bank may drop its dovish outlook for future policy as the recovery gathers pace. In light of the recent economic developments, some members of the MPC may jump on board with Mr. Sentance and push for a rate hike in an effort to stem the risks for inflation.

The Downside

Policy makers in the U.K. may continue to talk down the risks for price growth and maintain a dovish outlook given the ongoing weakness within the private sector. Moreover, with the new coalition in Britain tightening fiscal policy, the BoE may look to support the real economy throughout the remainder of the year as the growth outlook remains clouded with uncertainties.

How To Trade This Event Risk

Trading the given event risk may not be as clear cut as some of our previous trades as the BoE is widely anticipated to maintain its current policy in September. Nevertheless, an upward revision it the central bank’s growth and inflation forecast could set the stage for a long British Pound trade as investors weigh the prospects for future policy. Therefore, if the MPC delivers a hawkish policy statement, 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 set the initial stop at the nearby swing low or a reasonable distance, 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 lot to cost once the first trade reaches its mark in order to preserve our profits.

In contrast, the majority of the central bank may retain its latest assessment of the economy and see scope to maintain the expansion in monetary policy going forward. As a result, if the BoE expects price pressures to diminish further over the medium-term and lowers its economic forecast, we will favor a bearish outlook for Cable. We will implement the same strategy for a short pound-dollar trade as the long position laid out above, just in reverse.

Potential Price Targets For The Release

GBPUSD_Trading_the_Bank_of_England_Interest_Rate_Decision_body_ScreenShot006.gif, GBP/USD: Trading the Bank of England Interest Rate Decision

Impact the Bank of England Rate Decision has had on GBP during the last month

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

Aug 2010

08/05/2010 11:00 GMT

0.50%

0.50%

-27

-20

August 2010 Bank of England Interest Rate Decision

The Bank of England voted 8-1 to hold the benchmark interest rate at 0.50% and maintain its asset purchase target at GBP 200B in August, which was largely in-line with forecasts. As expected, board member Andrew Sentance continued to dissent against the majority and pushed for a 25bp rate hike for the third time in an effort to stem the risks for inflation. The central bank went onto say that the MPC “considered arguments in favor of a further easing,” while others saw scope for a “small increase” as inflation continues to hold above the government’s 3% limit for price growth. As policy makers fail to meet on common ground, there could be a growing split within the MPC as the central bank maintains its dual mandate to ensure price stability while fostering full-employment. As a result, market participants may raise speculation for the BoE to start withdrawing monetary support over the coming months, which could stoke a rise in interest rate expectations as investors weigh the prospects for future policy.

GBPUSD_Trading_the_Bank_of_England_Interest_Rate_Decision_body_ScreenShot003.png, GBP/USD: Trading the Bank of England Interest Rate Decision

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.

GBPUSD_Trading_the_Bank_of_England_Interest_Rate_Decision_body_00001_GBP.jpg, GBP/USD: Trading the Bank of England Interest Rate DecisionGBPUSD_Trading_the_Bank_of_England_Interest_Rate_Decision_body_00002_GBP.jpg, GBP/USD: Trading the Bank of England Interest Rate Decision

Questions? Comments? Join us in the DailyFX Forum

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

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08 September 2010 19:35 GMT