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GBP/USD: Trading the U.K. Public Finances Report

GBP/USD: Trading the U.K. Public Finances Report

2010-05-19 18:25:00
David Song, Currency Strategist
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Trading the News: U.K. Public Sector Net Borrowing

Why Is This Event Important:


As the U.K. budget deficit balloons to record highs, the monthly public finances report is likely to stoke increased volatility in the exchange rate as Prime Minister David Cameron pledges to cut government spending and reduce the shortfall. As a result, tightening in fiscal policy could lead the Bank of England to maintain a loose policy stance in the second-half of the year as Governor Mervyn King holds a cautious outlook for the economy and sees additional downside risks for growth.

What’s Expected:
Time of release:        05/21/2010 08:30 GMT, 4:30 EST
Primary Pair Impact :    GBPUSD
Expected:         10.9B
Previous:         23.5B

Will This Be Market Moving (Scenarios):

Public sector borrowing in the U.K. is forecasted to rise GBP 10.9B in April after expanding GBP 23.5B in the previous month but at the same time, a separate report by the BoE is expected to show mortgage approvals by the major banks in the U.K. rise 54K after increasing 52K in March as the government continues to support the real economy. As government officials in the U.K. see the recovery gathering pace, investors may discount the rise in budget deficit and look towards the expansion in private lending, which could produce choppy price action in the exchange rate as investors weigh the outlook for future growth.

The Upside

The drop in jobless claims paired with the rebound in private sector consumption would certainly allow the government to cut back on spending, and a less-than-expected rise in the budget deficit could reinforce an enhanced outlook for the region as the recovery gathers steam. As public finances improve,  the BoE may raise its economic assessment and see increased scope to normalize policy further this year as the long-term risks for the economy taper off.

The Downside

However, as policy makers continue to see a risk for a protracted recovery, the government may increase its efforts to support the economy as the MPC notice additional downside risks for growth. In light of the current situation, public borrowing may exceed forecasts, which could spark increased selling pressures on the exchange rate as the rise in the budget deficit weighs on the outlook for long-term growth.

How To Trade This Event Risk


Price action following the slower pace of growth in the budget deficit could set the stage for a long British Pound position as Prime Minister Cameron aims to cut the shortfall going forward. Therefore, if public borrowing expands GBP 5.0B or less in April, we will look for a green, five-minute candle following the release to generate 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, 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 breakeven once the first trade reaches its mark in order to preserve our profits.

In contrast, the focus on economic growth by the former government could lead to a larger-than-expected rise in public borrowing, and the fears surrounding the ballooning deficit could weigh on the exchange rate as policy makers maintain a cautious outlook for the region. As a result, if the shortfall widens GBP 10.9B or greater from the previous month, we will favor a bearish outlook for the sterling, and will implement the same strategy for a short pound-dollar trade as the long position mentioned above, just in reverse.

05.19_TTN1

Impact that the U.K. Public Sector Borrowing has had on GBP during the last month

05.19_TTN2

March 2010 U.K. Public Sector Net Borrowing

Public sector borrowing in the U.K. jumped GBP 23.5B in March amid expectations for a GBP 24.0B shortfall, and marked the biggest deficit since recordkeeping began in 1993 as Prime Minister Gordon Brown continues to support the real economy. As the government takes unprecedented steps to encourage a sustainable recovery, the ballooning deficit will certainly put additional pressures on monetary policy, which could lead the Bank of England to maintain a dovish bias going into the second-half of the year as Governor Mervyn King expects the ongoing slack in the private sector to weigh on price growth. However, as the rebound in economic activity gathers pace, the central bank may raise its assessment for growth and inflation and lead the central bank to normalize monetary policy further over the coming months. 05.19_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

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

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