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. Similar to the situation last month, the market is heavily pricing in a quarter point cut to the benchmark lending rate, while the Bloomberg consensus of economists’ forecasts is calling for no change. If there is another lowering of the overnight rate, it would be the first back to back cut since the BoE aggressively loosened monetary policy after the terrorist attacks in New York in September of 2001.
Trading the News: Bank of England Rate Decision
What’s Expected
Time of release: 01/10/2008 12:00 GMT, 07:00 EST
Primary Pair Impact : GBPUSD
Expected: 5.50%
Previous: 5.50%
How To Trade This Event Risk
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. Similar to the situation last month, the market is heavily pricing in a quarter point cut to the benchmark lending rate, while the Bloomberg consensus of economists’ forecasts is calling for no change. If there is another lowering of the overnight rate, it would be the first back to back cut since the BoE aggressively loosened monetary policy after the terrorist attacks in New York in September of 2001. Looking at the data build up heading into the MPC’s gathering, it is clear there is reason to factor in the risk of a cut. Growth indicators have cooled substantially. The leading indicators index slipped to its lowest level since June of 2006, consumer’s willingness to make major purchases plunged to a 16 year low, and both financial and credit markets are still unstable (the factor that many believe was the key to the policy authority’s first rate cut). And, on the other side of the coin, offsetting inflation pressures are quickly abating with core inflation at 16 month lows. While the uncertainty engendered between economists and traders could lead to a jump in volatility and possibly trend change for GBPUSD, we should learn a lesson of caution from last months’ reaction. The ‘surprise’ cut last month, saw only a modest dip. With a calculated 59 percent chance of another easing Thursday, the impact of a cut may be muted.
Between the market’s and economists’ forecasts, the bigger fundamental surprise and subsequent market reaction would likely be found in upsetting traders’ outlook. 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 more hawkish statement (compared to the previous one) be released with the decision; and such an extra may be needed to clear former support levels that are now strong technical ceilings. 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.
How do you think GBPUSD will react to the rate decision? Discuss it with DailyFX analysts and other traders in the GBPUSD thread of the DailyFX forum.
Written by: John Kicklighter, Currency Analyst for DailyFX.com
Contact John Kicklighter about this article at <[email protected]>