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

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Wednesday, 06 May 2009 11:32:50 GMT
Written by David Song, Currency Analyst

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The Bank of England is widely expected to hold the benchmark interest rate steady at the record-low of 0.50% and is likely to uphold its GBP 75B asset purchase program in an effort to stimulate the ailing economy however, as the outlook for growth and inflation remains bleak, policymakers may signal that more need to be done as the region faces its worst economic downturn in over half a century.

Trading the News: Bank of England Rate Decision

What’s Expected
Time of release: 05/07/2009 11:00 GMT, 07:00 EST
Primary Pair Impact: GBPUSD
Expected: 0.50%
Previous: 0.50%

Impact the Bank of England Rate Decision has had on GBPUSD over the last 2 months
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April 2009 Bank of England Rate Decision
The BoE April minutes showed that the MPC voted 9-0 to hold the key rate at 0.50%, and agreed to carry out the current policies set in place to steer the nation out of a recession. The central bank pledged to spend GBP 75B in asset purchases at the meeting in March as the region faces its worst economic contraction in over half a century, and said that 1Q GDP is likely to contract at ‘a similar rate’ to the 1.6% drop during the fourth quarter. Moreover, the BoE noted that ‘the initial efforts of the committee’s asset purchase program had been encouraging,’ but reinforce a weakening outlook for prices as ‘inflation still seemed likely to fall below’ the 2% target. Nevertheless, the jump in government spending paired with record-low borrowing costs should help to stem the downside risks for growth and price stability however, economic activity is likely to remain subdued throughout the year as the downturn in the global economy intensifies.

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March 2009 Bank of England Rate Decision
The Bank of England voted unanimously to slash the benchmark interest rate by another 50bp to a record-low of 0.50%, and pledged to purchase as much as GBP75B of government and corporate debt in an effort to steer the economy out of a deepening recession. Moreover, BoE Governor Mervyn King said that the interest rate in the U.K. is ‘very unlikely’ to fall lower from its current level as the board adopts quantitative easing to stimulate the ailing economy, and went onto say that ‘the inflation target provides a natural guide’ for monetary policy going forward. Nevertheless, as the BoE concludes its easing cycle, long-term expectations for higher rates could boost demands for the British pound over the near-term however, as the economic docket continues to reinforce a dour outlook for growth and inflation, fundamental headwinds are likely to weigh on the exchange rate as the economic downturn in the region intensifies.

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What To Look For Before The Release
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:

Bullish Scenario:

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.

Bearish Scenario:


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.

How To Trade This Event Risk

The Bank of England is widely expected to hold the benchmark interest rate steady at the record-low of 0.50% and is likely to uphold its GBP 75B asset purchase program in an effort to stimulate the ailing economy however, as the outlook for growth and inflation remains bleak, policymakers may signal that more need to be done as the region faces its worst economic downturn in over half a century. The advanced 1Q GDP reading for the U.K. reinforced fears of a deepening recession as the growth rate contracted at its fastest pace since 1979, and conditions are likely to get worse as businesses continue to scale back on production and employment in order to weather the downturn in global trade. As a result, market participants speculate that the BoE will utilize the remaining GBP 75B authorized by the Chancellor of the Exchequer, Alistair Darling, in the second-half of 2009 as policymakers expect price pressures to fall below the 2% target this year, and may continue to hold the overnight lending rate at the record-low in 2010 as the International Monetary Fund forecasts a deepening contraction in the region. Meanwhile, the Organization for Economic Cooperation and Development said that ‘further fiscal measures’ could be warranted after lowering their growth forecasts for the U.K. at the end of March however, as BoE Governor Mervyn King objects to increase the budget deficit further, Chancellor Darling proposed to hike taxes for the top earners in the country in order to contain the surge in government spending. As the HM Treasury targets citizens who earn GBP100K or more to help finance the strains in the government’s balance sheet, some speculate that the move could pose a threat to long-term stability as high net-work individuals plan to leave the country, while others argue that policymakers should look elsewhere for additional sources of revenue as the financial industry, which has helped the government to raise funds during the economic boom on the back of capital-gain and corporate taxes, falters. Moreover, after cutting the 2009 growth forecast to -4.3% from an initial projection of -2.3, the National Institute of Economic and Social Research (NIESR) said that it would be nearly impossible for the public debt to return to 40% of GDP until 2023, while the European Commission anticipates the budget deficit to reach ‘close to 85%’ of GDP by 2010/2011 as Mr. Darling plans to borrow GBP 175B this year, and the risks to long-term stability may lead the BoE to take drastic steps in the months ahead to jump-start the economy as growth prospects deteriorate at a record-pace.

Trading the given event risk may not be as clear cut as some of our other trades as the BoE is widely expected to hold the benchmark interest rate steady at the record-low but nevertheless, as the central bank maintains a wait-and-see approach and spot some encouraging signs for a recovery, commentary following the rate decision could pave the way for a long British pound trade as policymakers continue to pump up the money supply. Therefore, if the BoE reinforces an improved outlook for growth, and signals that the outlook for long-term stability remains in-line with expectations, we will look for a green, five-minute candle following the event 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 reasonable distance taking volatility into account), and this risk will establish our first target. Our second target will be based on discretion, and in an effort to preserve our profits, we will move the stop on the second lot to breakeven once the first trade reaches its target.

At the same time, the BoE rate decision could instill a bearish outlook for the British pound as policymakers continue to push into uncharted territory, and the downside risks for long-term stability could weigh on the markets as the central bank adopts a wait-and-see approach. As a result, if policymakers continue to hold a dour outlook for growth and inflation, and see a risk to long-term stability, we will look for sell the Sterling, and will follow the same strategy for a short pound-dollar trade as the long position mentioned above.

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