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

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

2010-05-17 19:24:00
David Song, Currency Strategist
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Trading the News: U.K. Consumer Price Index

Why Is This Event Important:


Policy makers in the U.K. have certainly expressed concerns regarding the stickiness in prices, and the central bank may drop its dovish outlook in the second-half of 2010 as the headline reading for inflation is expected to exceed the Bank of England’s upper limit for the third time this year. As a result, Governor Mervyn King will ultimately have to write a letter to the Chancellor of the Exchequer George Osborne over the coming months and explain what the central bank intends to do to bring inflation back towards the 2% target as policy makers expect to see above-target inflation throughout this year.

What’s Expected:

Time of release:        05/18/2010 08:30 GMT, 4:30 EST
Primary Pair Impact :    GBPUSD
Expected:         3.5%
Previous:         3.4%

Will This Be Market Moving (Scenarios):


Consumer prices in Britain are expected to increase 0.4% in April following the 0.6% expansion in the previous month, while the annualized rate is forecasted to rise 3.5% from the previous year, which would be the fastest pace of growth since January. At the same time, the core rate of inflation, which strips out volatile items such as energy and food, is projected to fall back to 2.9% after unexpectedly increasing 3.0% in March, and Governor King may adopt a neutral bias in the second-half of the year as he continues to see a risk for a protracted recovery.

The Upside


As the economic recovery gathers pace, businesses may increase their temperament to pass on higher costs to consumers, which could lead to higher price growth over the medium-term and push the BoE to scale back its loose policy. As price pressures intensify, market participants would also increase speculation for a rate hike later this year as the central bank sees inflation holding above the 2% target in 2010, which could stoke a rebound in the GBP/USD as the daily RSI remains in oversold territory.

The Downside

However, as households continue to face tightening credit conditions paired with the deterioration in the labor market, firms may turn increasingly reluctant to increase prices, and weaker inflation would certainly give the MPC scope to maintain a dovish policy stance over the coming months as it aims to encourage a sustainable recovery. As a result, if price growth expands at a slower pace from the previous month, investors may scale back speculation for a BoE rate hike later this year as the central bank sees “increased” downside risks for growth.

How To Trade This Event Risk

A higher rate of inflation favors a bullish outlook for the British Pound as the stickiness in prices becomes an increased concern for the central bank, which could lead the MPC to drop its dovish bias and lead the board to normalize policy further over the coming months as it aims to balance the risks for the economy. Therefore, if the CPI expands 3.5% or greater from the previous year, 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 place 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 its mark in order to preserve our profits.

In contrast, the ongoing weakness in the private sector paired with tightening credit conditions may lead businesses to keep a lid on prices, and price action following a dismal CPI report could set the stage for a short Cable trade as investors speculate on the outlook for future policy. As a result, if price growth falls back to 3.3% or slips back below the central bank’s upper limit for inflation, we will favor a bearish outlook for the U.K. currency, and will implement the same strategy for a shot pound-dollar trade as the long position laid out above, just in reverse.

05.17_TTN1

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

05.17_TTN2

March 2010 U.K. Consumer Price Index

Consumer prices in the U.K. grew 0.6% in March, which topped expectations for a 0.3% rise, while the annualized rate expanded 3.4% from the previous year to exceed the central bank’s upper limit for the second time this year. At the same time, the core rate of inflation unexpectedly increased to 3.0% from 2.9% in February, with the breakdown of the report showing energy prices jumping 8.5% from the previous year to lead the advance, while the costs for industrial goods expanded at an annual pace of 3.7% after rising 3.3% in the previous month. After writing a letter to Chancellor of the Exchequer in February, Governor Mervyn King did not have to write a letter this time around since he is only required to do so in three-month intervals, and the central bank may drop its dovish outlook over the coming months as price pressures intensify. 05.17_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

Questions? Comments? Join us in the DailyFX Forum

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

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