GBPUSD: Trading the U.K. Consumer Price Report

Trading the News: U.K. Consumer Price Index

What’s Expected:

Time of release: 09/18/2012 8:30 GMT, 4:30 EDT

Primary Pair Impact: GBPUSD

Expected: 2.5%

Previous: 2.6%

DailyFX Forecast: 2.5% to 2.8%

Why Is This Event Important:

The headline reading for U.K. inflation is expected to fall back to 2.5% in August and the slowdown in price growth may dampen the appeal of the British Pound as it raises the scope for additional monetary support. Indeed, there’s speculation that the Bank of England will expand its balance sheet further as the region struggles to emerge from the double-dip recession, but another uptick in consumer prices may encourage the central bank to soften its dovish tone for monetary policy as the new lending scheme gets underway. As the BoE maintains its current policy it September, Monetary Policy Committee member Ben Broadbent argued that faster price growth would limit the scope for more quantitative easing, and the central bank may scale back its forecast for undershooting the 2% target for inflation as the recovery slowly gathers pace.

Recent Economic Developments

The Upside

The Downside

Higher costs paired with the uptick in wage growth may push businesses to raise consumer prices, and another higher-than-expected inflation report may produce fresh monthly highs in the GBPUSD as it dampens speculation for more QE. However, the ongoing weakness in consumer sentiment along with the persistent slack in the housing market may persuade U.K. firms to offer discounted prices, and a slowdown in price growth may spark a near-term correction in the pound-dollar as market participants see the MPC expanding the asset purchase program beyond GBP 375B.

Potential Price Targets For The Release

The GBPUSD looks poised for a short-term correction as the relative strength index continues to show an overbought signal, and a soft inflation print may produce a more meaningful move to the downside as it fuels speculation for more easing. However, the bullish momentum in the sterling may gather pace should consumer prices top market forecast for the second consecutive month, and we may see the pound-dollar threaten the April high (1.6300) as the data curbs bets for additional asset purchases.

How To Trade This Event Risk

Expectations for slower inflation instills a bearish outlook for the sterling, but the market reaction may pave the way for a long British Pound trade should the data beat market expectations for the second month. Therefore, if consumer prices unexpectedly advance from the previous month, we will need a green, five-minute candle following the release to generate a buy entry on two-lots of GBPUSD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will establish our first objective. The second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade hits its mark in an effort to lock-in our profits.

In contrast, the ongoing slack in the real economy paired with the weakness in household sentiment may continue to drag on consumer prices, and a downtick in the headline reading for inflation may spark a bearish reaction in the sterling as market participants continue to call for additional monetary support. As a result, if the CPI slips to 2.5% or lower, we will implement the same strategy for a short pound-dollar trade as the long position mentioned above, just in the opposite direction.

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

July 2012 U.K. Consumer Price Index

Consumer prices in the U.K. increased 2.6% in July after expanding 2.4% the month prior, while the core rate of inflation unexpectedly advanced 2.3% during the same period to mark the fastest pace of growth since March. Although the GBPUSD spiked above 1.5700 following the stronger-than-expected print, the initial reaction was short-lived, and we saw the sterling struggle to hold its ground during the North American trade as the pair ended the day at 1.5672.

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--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

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