GBP/USD: Trading the Bank of England Interest Rate Decision

The central bank in the U.K. kept the benchmark interest rate unchanged at 0.50% in June, and maintained its GBP 125B asset purchase program in an effort to stimulate the ailing economy. The Bank of England minutes showed the board voted unanimously to carry out its current policy objects in place, with the MPC stating ‘that the second-quarter decline in consumption would be less than the committee had previously anticipated.’

[U][B]Trading the News: Reserve Bank of Australia Interest Rate Decision[/B][/U]

[B]What’s Expected[/B]
Time of release: [B]07/09/2009 11:00 GMT, 07:00 EST[/B]
Primary Pair Impact : [B]GBPUSD[/B]
Expected: 0.50%
Previous: 0.50%

[B][U]Impact the RBA Rate Decision had on AUDUSD over the last 2 monthsmonths[/U][/B]

                                     [B]Period[/B]

                                   [B]Data Released[/B]

                                   [B]Estimate[/B]

                                   [B]Actual[/B]

                                   [B]Pips Change[/B]

         [B](1 Hour post event )[/B]

                                   [B]Pips Change[/B]

         [B](End of Day post event)[/B]

                                                     June 2009

                                   06/04/2009 11:00 GMT

                                   0.50%

                                   [B]0.50%[/B]

                      -248                          -211

                                                     May 2009

                                   05/07/2009 11:00 GMT

                                   0.50%

                                   [B]0.50%[/B]

                                   +4

                                   -78

                         [U]

June 2009 Bank of England Rate Decision[/U]

                        The central bank in the U.K. kept the benchmark interest rate unchanged at 0.50% in June, and maintained its GBP 125B asset purchase program in an effort to stimulate the ailing economy. The Bank of England minutes showed the board voted unanimously to carry out its current policy objects in place, with the MPC stating ‘that the second-quarter decline in consumption would be less than the committee had previously anticipated.’ Moreover, the BoE said that the economic downturn has ‘receded  somewhat,’ with the housing market ‘stabilizing,’ and the comments encourage an improved outlook for Europe’s second largest economy as policymakers anticipate an economic recovery later this year. As a result, Governor Mervyn King may continue to keep a floor on borrowing costs as growth prospects improve, and long-term expectations for higher interest rates may continue to drive the British pound higher over the near-term.              

[U]May 2009 Bank of England Rate Decision[/U]

                        The Bank of England held the benchmark interest steady at the record-low of 0.50% in May, and voted unanimously to expanded its asset purchase program by GBP 50B to a total of GBP 125B in an effort to steer the economy out of recession. The BoE minutes showed some of the board members argued ‘for a larger stimulus’ as Governor Mervyn King expects the region to face a ‘slow and protracted recovery,’ with the MPC stating that ‘inflation, in the absence of a further monetary stimulus, could significantly undershoot the 2% target in the medium term.’ As the central bank holds a dovish outlook for future price growth, market participants speculate that the board will use the remaining GBP 25B allotted by the Chancellor of the Exchequer to jump-start the economy as policymakers anticipate the annual rate of inflation to hold below the BoE’s target until 2012.’             

[B]What To Look For Before The Release[/B]
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:

                        [U][B]Bullish Scenario:[/B][/U]
         
         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 AUD 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 AUDUSD ahead of the data release.
                       [U][B]Bearish Scenario:[/B][/U]
         
         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 AUD 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 AUDUSD ahead of the data release.                               


[B]
How To Trade This Event Risk [/B]

The Bank of England is widely anticipated to hold the benchmark interest rate steady at the record-low of 0.50% in July as policymakers expect growth prospects to improved throughout the second half of the year, and long-term expectations for higher interest rates could lead the British Pound higher as market participants forecast the central bank to tighten policy over the next 12 months. A Bloomberg News survey shows all of the 54 economists polled project the MPC to hold borrowing steady this month as policymakers adopt a wait-and-see approach, while Credit Suisse overnight index swaps continues to highlight expectations for a rate hike next year as the central bank puts a floor on the interest rates. At the same time, the British Chambers of Commerce called upon the BoE to expand its asset purchase program this month, and utilize the remaining GBP 25B allotted by the Chancellor of the Exchequer Alistair Darling in an effort to jump-start the ailing economy. The business group went onto say that the central bank should seek authorization to enlarge the scope of the program beyond GBP 150B as the region faces its worst economic downturn in over half a century, with the Shadow Monetary Policy Committee supporting the call for further easing in monetary policy. The final 1Q GDP reading reinforced a weakening outlook for Europe’s second largest economy as the growth rate plunged at an annual rate of 4.9% to mark the biggest decline since 1958, while retail spending unexpectedly dropped in May for the first time in three-months, and the data highlights the dire situation in the U.K. as businesses continued to scale back on production and employment in an effort to lower their cost structure. Furthermore, a report by the central bank showed home equity withdrawals fell at its fastest pace on record during the first quarter as households face tightening credit conditions, while mortgage applications increased to 43.4K in May to mark the smallest rise since recordkeeping began in 1993, and the economic outlook remains bleak as consumers continue to face a weakening labor market paired with fears of a protracted downturn. Nevertheless, the National Institute of Economic and Social Research encouraged an improved outlook for future growth as the group saw economic activity ‘stagnating rather than continuing to contract at a sharp pace’ this month however, as BoE Governor Mervyn King forecasts the recovery to be ‘a long, hard slog,’ the central bank may take additional steps to steer the nation out of the recession as the MPC maintains a dovish policy stance.

Attempting to trade the given event risk may not be as clear cut as some of our previous trades as market participants expect the BoE to carry out its current policies in place but nevertheless, price action following the rate decision could set the stage for a long pound trade as investors anticipate the central bank to tighten policy over the next 12-months. Therefore, if the MPC keeps rates on hold and retains its GBP 125B program for asset purchases, we will look for a green, five-minute candle following the rate decision to confirm a buy entry on two-lots of GBP/USD. Once these conditions are met, we will place our initial stop at the nearby swing low, or a reasonable distance taking volatility into account, and this risk will establish our first target. Our second objected will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to preserve our profits.
In contrast, the downturn in global trade paired with expectations for a slower recovery could lead the BoE to take further steps to stem the downside risks for growth and inflation, and the British pound could face increased selling pressures over the near-term if the central bank decides to expand its asset purchase program and maintains a dour outlook for future growth. As a result, if the MPC utilizes the remain GBP 25B authorized by Chancellor Darling and sees a risk for a protracted downturn, we will favor a bearish outlook for Cable, and will follow the same strategy for a short pound-dollar trade as the long position mentioned above, just in reverse.