Consumer prices in the U.K. are forecasted to rise to an annualized rate of 3.5% in January, which would be the highest rate of inflation since November 2008, and the marked rise in price growth could stoke increased volatility in the exchange rate as the Bank of England maintains it dual mandate to ensure price stability while fostering full-employment.
[U][B]Trading the News: U.K. Consumer Price Index[/B][/U]
[U][B]What’s Expected[/B][/U]
Time of release: 02/16/2010 09:30 GMT, 04:30 EST
Primary Pair Impact : GBPUSD
Expected: 3.5%
Previous: 2.9%
[U][B]
Effects the U.K. Consumer Price Index has had over GBPUSD for the past 2 months[/B][/U]
[U]December 2009 U.K. Consumer Price Index[/U]
U.K. consumer prices rose at a record pace in December, with the headline reading for inflation jumping to an annualized pace of 2.9% from 1.9% in the previous month, and the Bank of England may have to write a letter to Chancellor of the Exchequer Alistair Darling explaining why price pressures have risen so sharply over as market participants expect price growth to accelerate over the short-term. A deeper look at the report showed the cost of transportation surged 8.7% from the previous year to lead the advance, which was driven by higher energy prices, while prices for clothing and footwear slumped 3.5% from 2008. However, the BoE expects price pressures to fall back below the 2% and average 1.5% towards the end of the year as economic activity remains weak, and we may see the MPC maintain a dovish policy stance as they aim to encourage a sustainable recovery in the U.K. [IMG]http://forums.babypips.com/export/story-images/2010/02/fundamental/daily_briefing/daily_pieces/trading_news_reports/02.12_TTN2.jpg[/IMG] [U]November 2009 Consumer Price Index[/U]
Price pressure in the U.K. increased more than expected in November, with the headline reading for inflation expanding to an annualized pace of 1.9%, while consumer prices increased 0.3% from the previous month, led by higher fuel costs. The breakdown of the report showed transportation costs increased 6.9% from the previous year to lead the advance, with alcohol & tobacco prices gaining 4.5%, while prices for clothing and footwear slumped at an annual pace of 6.8% during the month. As a result, the Bank of England may turn increasingly hawkish over the coming months as Chancellor of the Exchequer forecasts price growth to rise to 3.0% in the following year, and the central bank may look to normalize policy in 2010 as the BoE aim to balance the risks for growth and inflation. [IMG]http://forums.babypips.com/export/story-images/2010/02/fundamental/daily_briefing/daily_pieces/trading_news_reports/02.12_TTN3.jpg[/IMG] [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 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. [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 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. [IMG]http://forums.babypips.com/export/story-images/2010/02/fundamental/daily_briefing/daily_pieces/trading_news_reports/00001_GBP.jpg[/IMG] [IMG]http://forums.babypips.com/export/story-images/2010/02/fundamental/daily_briefing/daily_pieces/trading_news_reports/00002_GBP.jpg[/IMG] [B]How To Trade This Event Risk [/B]
Consumer prices in the U.K. are forecasted to rise to an annualized rate of 3.5% in January, which would be the highest rate of inflation since November 2008, and the marked rise in price growth could stoke increased volatility in the exchange rate as the Bank of England maintains it dual mandate to ensure price stability while fostering full-employment. A report by the British Retail Consortium showed shop prices increased at an annual pace of 2.3% in January, driven by a rise in non-food items, while a separate report showed producer prices rose to 3.8% during the same period to mark the highest reading since 2008. However, the Bank of England held a dovish tone in its quarter inflation report release earlier this month and said that the recovery was “somewhat weaker” than previous expected, with the ongoing slack in the economy continuing to weigh on the outlook for inflation. As a result, the central bank anticipates to see a moderate recovery this year and forecasts price growth to average 1.2% over the next two-years as the economic upswing remains weak.
At the same time, the BoE projects short-term price growth to top out around 3.3% in the first-quarter, and we are likely to see Governor Mervyn King write a letter to Chancellor of the Exchequer Alistair Darling explaining what the central bank intends to do to bring CPI inflation back to the 2% target as it exceeds the upper bounds for price stability. However, as the MPC aims to encourage a sustainable recovery in the U.K., the central bank maintained the option to expand its asset purchase program at its policy meeting earlier this month, and the BoE may hold a dovish outlook throughout the first-half of the year as they continue to see a risk for a protracted recovery. As a result, a drop in interest rate expectations could weigh on the exchange rate going forward, and speculation for further easing would certainly lead the British Pound to weaken against its currency counterparts as central banks across the globe prepare to normalize policy this year.
Trading the given event risk favors a bullish outlook for Cable as price pressures exceed the forecast held by the central bank, and price action following the release could set the stage for a long British Pound trade as investors speculate the BoE to tighten policy later this year. Therefore, if the headline reading increased to 3.3% or higher, we will need to see a green, five-minute candle following the release to confirm a buy entry on two-lots of GBP/USD. Once these conditions are met, we will place the initial stop at the nearby swing low or a reasonable distance, and this risk will establish our first target. The second objective will be based on discretion, and we will shift the stop on the second lot to cost once the first trade reaches its target in an effort to lock-in our profits.
On the other hand, the ongoing slack in the domestic economy paired with the slump in wage growth could weigh on inflation, and subdued price pressures is likely to drag on the exchange rate as the BoE holds a dovish outlook for future policy. As a result if the CPI fails to meet market expectations of unexpectedly slips below 2.9%, we will favor a bearish outlook for Cable, and will utilize the same strategy for a short pound-dollar trade as the long position laid out above, just in reverse.
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[I]To discuss this report contact David Song, Currency Analyst: <[email protected]>[/I]