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

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

2010-03-22 18:55:00
David Song;Michael Wright,
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Trading the News: U.K. Consumer Price Index

What’s Expected
Time of release:        03/23/2010 09:30 GMT, 05:30 EST
Primary Pair Impact :    GBPUSD
Expected:         3.1%
Previous:         3.5%

Effects the U.K. Consumer Price Index has had over GBPUSD for the past 2 months

03.22_TTN1

January 2010 U.K. Consumer Price Index

Price pressures in the U.K. accelerated at the fastest pace in 14 months, led by an increase in sales tax. Consumer prices climbed an annualized 3.5% in January, marking the highest reading since November 2008, which led Bank of England Governor Mervyn King to write a public letter explaining the recent rise prices. At the same time, inflation slid 0.2% after rising 0.6% in December, which exceeded economists’ expectations for a 0.1% decline, the Office for National Statistics in London announced.  Taking a look at the breakdown of the report, transport costs rose 11%, advancing the most on record, while prices for tobacco and alcohol also edged higher, adding to the acceleration in inflation.  Looking ahead, the Bank of England said that it expects price growth to fall back towards 0.9% later this year and stay below the 2% target as ongoing slack in the economy continues to dampen inflation. 03.22_TTN2

December 2009 Consumer Price Index

U.K. consumer prices rose at a record pace in December, with the headline reading for inflation jumping to an annualized pace of 2.9% from 1.9% in the previous month, and the Bank of England may have to write a letter to Chancellor of the Exchequer Alistair Darling explaining why price pressures have risen so sharply over as market participants expect price growth to accelerate over the short-term. A deeper look at the report showed the cost of transportation surged 8.7% from the previous year to lead the advance, which was driven by higher energy prices, while prices for clothing and footwear slumped 3.5% from 2008. However, the BoE expects price pressures to fall back below the 2% and average 1.5% towards the end of the year as economic activity remains weak, and we may see the MPC maintain a dovish policy stance as they aim to encourage a sustainable recovery in the U.K. 03.22_TTN3

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.
00001_GBP 00002_GBP

How To Trade This Event Risk

The British Pound could face increased selling pressures over the next 24 hours of trading as economists forecast consumer prices in the U.K. to rise at an annual pace of 3.1% in February after expanding 3.5% in the previous month, and the pull back in price growth may lead the Bank of England to maintain a dovish outlook for future policy as it aims to encourage a sustainable recovery. However, a report by the Office for National Statistics showed producer prices increased at an annualized rate of 4.1% in February to mark the biggest expansion since December 2008, with the core rate increasing 2.9% to top forecasts for a 2.8% rise, and the advance in factory prices could stoke higher consumer prices as the recovery gathers momentum. Meanwhile, Bank of England board member Andrew Sentance held a cautious outlook for the economy during an interview with CNBC television and said that he would not “rule out some new shocks emerging on the financial front, which could lead to a “double dip recession,” but went onto say that inflation remains above the central banks February forecast despite the ongoing weakness in the private sector.

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 growth and inflation. 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, while inflation is projected to fall back below the 2% target later this year. 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. At the same time, BoE board member Kate Barker held a dovish tone during an interview with the Western Morning News and saw a risk for “a quarter when GDP falls” as she expects a “bumpy and fragile” recovery, and the central bank may hold a dovish policy stance going into the second-half of the year as the MPC sees scope to expand its asset purchases program beyond the GBP 200B target.

Expectations for a pull back in inflation could weigh on the exchange rate as the central bank maintains a dovish outlook for future policy, but an enhanced CPI reading could drive the British Pound higher as investors raise expectations for a rate hike later this year. As a result, if consumer prices increase at an annual pace of 3.4% or higher, we would need to a see a green, five-minute candle following the release to confirm 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 volatility into account, and this risk will establish our first mark. 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 target in order to preserve our profits.

In contrast, the ongoing slack in the economy could lead to a weaker-than-expected CPI reading, which would certainly drag on the exchange rate as investors weigh the prospects for future policy. As a result, if the headline reading for inflation slips to 3.1% or lower, we will favor a bearish outlook for Cable, and will implement the same strategy for a short pound-dollar trade as the long position laid out above, just in reverse.

03.22_TTN4

Questions? Comments? Join us in the DailyFX Forum

To discuss this report contact David Song, Currency Analyst: instructor@dailyfx.com

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