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

Trading the News: U.K. Consumer Price Index

Why Is This Event Important:

As price pressures in the U.K. intensify, the recent decline in the British Pound is likely to be short-lived, and market participants may increase speculation for a rate hike later this year as inflation expands at the fastest face since November 2008. However, as the new coalition in Britain takes extraordinary steps to curb the budget deficit, the tough austerity measures could bear down on the recovery, and the central bank may retain a wait-and-see approach throughout the first-half of 2011 as the economic outlook remains clouded with high uncertainty.

What’s Expected:

Time of release: 02/15/2011 9:30 GMT, 4:30 EST

Primary Pair Impact : GBPUSD

Expected: 4.0%

Previous: 3.7%

DailyFX Forecast: 3.8% to 4.0%

Will This Be Market Moving (Scenarios):

Consumer prices in the U.K. are forecasted to increase at an annualized pace of 4.0% in January after expanding 3.7% in the previous month, while the core rate of inflation is projected to hit a record high of 3.1% during the same period. As price growth accelerates, the Bank of England may show a greater willingness to withdraw monetary support this year, and the central bank may hold a highly hawkish outlook in its quarter inflation report due out on February 16 as the economic recovery gradually gathers pace.

The Upside

As consumer inflation expectations advance to the highest level since 2008, with producer prices growing at the fastest pace since May, firms may see scope to pass on higher costs onto consumers as private sector activity improves. A marked rise in inflation is spark a bullish reaction in the British Pound as the central bank maintains a hawkish outlook for future policy, and the GBP/USD may retrace the decline from earlier this month as investors raise bets for a rate hike later this year.

The Downside

However, as Britons cope with the tepid recovery in the labor market paired with the ongoing weakness in the housing market, the substantial margin of slack within real economy may bear down on price growth, and the firms may look to absorb higher costs in an effort to drive demands. In turn, a weaker-than-expected inflation report could exacerbate the recent decline in the exchange rate, and the GBP/USD may retrace the advance from the previous month as it searches for support.

How To Trade This Event Risk

Expectations for a higher rate of inflation certainly favors a bullish outlook for the sterling, and price action following the report could set the stage for a long British Pound trade as investors expect the BoE to hike borrowing costs later this year. Therefore, if consumer prices expand 4.0% or greater from the previous year, we will need a green, five-minute candle following the release 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 after taking market 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 lot to cost once the first trade reaches its mark in order to preserve our profits.

In contrast, the ongoing weakness within the private sector paired with the tough austerity measures could bear down on price growth, and a slower-than-expected pace of price growth could weigh on the exchange rate as interest rate expectations falter. As a result, if consumer prices unexpectedly hold steady or expands less than 4.0% from the previous year, we will look to 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

Impact that the U.K. Consumer Price report has had on GBP during the last month

December 2010 U.K. Consumer Price Index

Consumer prices in the U.K. increased at an annualized pace of 3.7% in December amid forecasts for a 3.4% expansion, while the core rate of inflation unexpectedly grew 2.9% from the previous year to mark the fastest pace of growth since June. A deeper look at the report showed prices for clothing and foot wear jumped 10.3% from the previous year to lead the advance, with the cost for food advancing 5.9%, while prices energy prices increased 2.8% after contracting 1.9% in November. As price growth in the U.K. accelerates, the Bank of England may show an increased willingness to gradually normalize monetary policy later this year, and speculation for a rate hike should help to prop up the British Pound as investors weigh the outlook for future policy. Indeed, market participants showed a bullish reaction to the higher-than-expected rate of inflation, with the GBP/USD popping to a daily high of 1.6059, but the rally was short-lived as the exchange rate settled at 1.5960 by the end of the day.

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