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Volatility and Strategy for GBP/USD Heading into BoE Decision

Volatility and Strategy for GBP/USD Heading into BoE Decision

2016-08-04 00:29:00
John Kicklighter, Chief Strategist
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Talking Points:

  • The Bank of England is set to announce its policy decision and release its Quarterly Inflation report at 11:00 GMT
  • This 'Super Thursday' policy carries far greater significance coming post Brexit and a surprising July hold
  • Markets, economists and traders differ widely on their expectations for this event while implied volatility is low

See how retail traders are positioning in the majors using the SSI readings on DailyFX's sentiment page.

Today's Bank of England (BoE) rate decision carries serious weight for the Pound and markets, yet there is relatively little evidence that the market is expecting market reaction that matches the significance of the event. This policy gather represents the 'Super Thursday' meeting whereby we are given the rate decision, statement and the Quarterly Inflation report. That is a comprehensive offering that can offer speculators something tangible to work with whether there is a move or not on policy. Amplifying the importance of this event materially, there is significant reason to expect the central bank to act now or in the near future.

Heading into the EU Referendum back in late June, the central bank made a clear and stark warning: a Brexit could lead to a UK recession and considerable financial stress. Those predictions rang loudly in the market's ears June 24th when the results of the vote were clear. The Pound suffered its biggest tumble on record as it plunged to multi-decade lows and volatility rippled throughout the global financial system. So far, we have seen sentiment data slump in the wake of the technical divorce, but we haven't seen the tangible evidence of economic fallout. At the mid-July BoE meeting, against expectations of a preemptive move to ward of economic slowdown, the central bank decided stand pat. Since then speculation for this meeting intensified while the projected outcomes diverged more broadly.

Looking at the expectations for this particular meeting; there is a significant divergence in projected outcome between economists, markets and traders. Economists are near certain of a 25 basis point cut, while traders place it as approximately a 43 percent probability and markets (swaps) are pricing in around a 30 percent chance. The divergence for reviving the long-dormant QE program is even greater. This vague outlook combined with the remarkably low short-term implied volatility measures suggests that there is considerable 'surprise' impact that can arise from this event. Is an easing effort going to be treated as relief from a frightful future? Would a hold be seen as a vote of confidence in the economy and hold in advantage for the Pound? We discuss this important and heavily speculated event in today's Strategy Video.

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