This Thursday, the markets and the Bloomberg consensus of economists’ forecasts agree that the BOE will enact a quarter point cut to the benchmark lending rate. However, looking at the data build up heading into the MPC’s gathering, there is reason to factor in the risk of no change in policy. With GBP/USD holding above support, will the pair rally on the news?
[B][U]Trading the News: Bank of England Rate Decision[/U][/B]
[B][U]What’s Expected[/U][/B]
Time of release: [B]02/07/2008 12:00 GMT, 07:00 EST[/B]
Primary Pair Impact[B] : GBPUSD[/B]
Expected: 5.25%
Previous: 5.50%
[B][U]
How To Trade This Event Risk
[/U][/B]Whereas the Bank of England’s monthly rate decision used to be overlooked in favor of the ECB’s gathering (thanks predominately to the latter’s news conference generating more event risk when both central bank’s voted to keep rates unchanged), the tables have clearly changed for the benefit of pound traders. The markets and the Bloomberg consensus of economists’ forecasts agree that the BOE will enact a quarter point cut to the benchmark lending rate. However, looking at the data build up heading into the MPC’s gathering, there is reason to factor in the risk of no change in policy. Fourth quarter UK GDP proved to be stronger than expected at an annualized 2.9 percent, while jobless claims fell more than forecasted in December and services PMI showed a surprising improvement in January. The most damning pieces of evidence, however, are the most recent inflation numbers. CPI in December stubbornly held at an annualized 2.1 percent – just above the Bank of England’s 2.0 percent target – while upside inflation risks remain given the impact of the drop in the British Pound on import costs. Furthermore, the minutes from the January MPC meeting reflected some hesitance to make policy more accommodative as the committee noted, “For most members, no change in Bank Rate was necessary this month…a second period during which inflation was significantly above target so soon after the one in Spring 2007, might be more likely to lead people to revise up their expectations of future inflation.” BOE Governor Mervyn King took it a step further two weeks ago when he said, “It is possible that inflation could rise to the level at which I would need to write an open letter of explanation, possibly more than one to the Chancellor.” With this “level” well above at 3.0 percent, it is rather obvious that inflation is on the mind of King, and will likely be a concern of other MPC members as well. The uncertainty engendered between economists, traders, and the data could lead to a jump in volatility and a possible trend change for GBPUSD.
Speculation of a rate cut from participants usually leads to prepositioning to counter the growing event risk. If the BOE holds steady at 5.50 percent, there is likely to be a considerable unwinding of shorts – and the pound’s steady decline over the past few months would only exacerbate such an outcome. For a long GBPUSD fundamental trade we will look for rates to be left unchanged. Our confidence in such a position would be substantially increased should a hawkish statement be released (though the bank does not typically issue policy statements when policy is unchanged). With the right fundamental mix, we will look for a green five minute candle to confirm entry on two lots with an initial stop at the nearby swing low (or reasonable distance). Our first target will equal risk on the position and the second will be based on discretion. To preserve profit, we will move the stop on the second half of the trade to break even when the first half takes profit. A short trade after a quarter point cut, on the other hand, may be dampened by prepositioning; so a bearish statement could help take out support levels. We will follow the same rules for entry for a short GBPUSD trade as the long described above, just in reverse.
