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GBP/USD: Trading the U.K. Preliminary 1Q GDP Report

GBP/USD: Trading the U.K. Preliminary 1Q GDP Report

2010-05-24 19:09:00
David Song, Currency Strategist
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Trading the News: U.K. Preliminary 1Q GDP

Why Is This Event Important:


As market participants weigh the prospects for a sustainable recovery in the U.K., and upward revision in the first-quarter GDP reading could drive the British Pound higher as the rebound in economic activity gathers pace. However, as the breakdown of the growth report is expected to show a 0.2% drop in private consumption, with gross capital formation forecasted to slip another 0.3% following the 2.7% contraction in the fourth-quarter, the ongoing weakness in the private sector would weigh on the outlook for future growth as household and business spending remains one of the leading drivers of growth.

What’s Expected:

Time of release:        05/25/2010 08:30 GMT, 4:30 EST
Primary Pair Impact :    GBPUSD
Expected:         0.3%
Previous:         0.2%

Will This Be Market Moving (Scenarios):


Economic activity in Britain is projected to expand 0.3% in the first quarter amid an initial forecast for a 0.2% rise in GDP, and conditions are likely to improve going forward as the Bank of England continues to support the real economy. However, central bank Governor Mervyn King maintained a cautious tone during the BoE’s quarterly inflation report and noted that the downside risks for growth have “increased somewhat,” and went onto say that the MPC maintains the option to expand its asset purchases over the coming months as policy makers aim to balance the risk for growth and inflation. 

The Upside

As the labor market improves, with business investments surging higher during the first three-months of 2010, the extraordinary steps taken on by the government could lead to a better-than-expected growth reading like we’ve seen in the fourth-quarter. As a result, the recent developments could stoke a rise in interest rate expectations, which may lead the central bank to normalize policy further this year as the MPC expects price pressures to hold above the 2% over the medium-term.

The Downside

However, as household sentiment remain weak, with businesses reluctant to expand their labor force, the ongoing weakness in the private sector could lead to a dismal GDP report, which could stoke selling pressures on the British Pound as investors weigh the outlook for future growth. Moreover, as the new government aims to reduce the budget deficit, BoE board member Kate Barker expects the central bank to face difficulty in managing the risks for the economy and sees the MPC facing “shocks and challenges” over the coming months, and Governor King may look to support the economy throughout the second-half of the year in an effort to foster a sustainable recovery. 

How To Trade This Event Risk

Forecasts for an upward revision in the growth rate favors a bullish outlook for the British Pound, and price action following the release could set the stage for a long Cable trade as economic conditions improve. Therefore, if GDP expands 0.3% or greater in the first-quarter, we will need to see a green, five-minute candle following the data to generate a buy entry on two-lots of GDP/USD. Once these conditions are fulfilled we will set the initial stop at the nearby swing low or a reasonable distance after taking 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 market in order to preserve our profits.

On the other hand, the ongoing weakness in the private sector could lead to a dismal growth report, and a weaker-than-expected GDP reading is likely to weigh on the exchange rate as market participants weigh the prospects for a sustainable recovery. As a result, if the growth rate expands less than 0.2% or unexpectedly contracts from the fourth-quarter, we will favor a bearish outlook for the sterling, and will utilize the same setup for a short pound-dollar trade as the long position laid out above, just in reverse.

05.24_TTN1

Impact the U.K. Preliminary 4Q GDP has had on GBP during the last quarter

05.24_TTN2

4Q 2009 U.K. Preliminary GDP

Economic activity in the U.K. expanded 0.3% in the fourth quarter, which topped expectations for a 0.2% rise in GDP, and the upward revision in the growth rate reinforces an improved outlook for the region as it emerges from the worst recession since the post-war period. The breakdown of the report showed private consumption increased 0.4% after unexpectedly holding flat in the fourth-quarter, with exports pushing 3.7% higher to top projects for a 3.4% expansion, while gross fixed capital formations slumped 3.1% amid forecasts for a 0.2% rise. As policy makers see a risk for a protracted recovery, the Bank of England is widely expected to maintain a loose bias for monetary policy throughout the first-half of the year, and is likely to maintain the option to expand its emergency measures further in an effort to encourage a sustainable recovery. 05.24_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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