Impact of U.K. Consumer Prices on GBPUSD over the last 3 months
Price pressures in the U.K. reached its highest level since recordkeeping began in 1997 as the consumer price index spiked to 5.2% from 4.7% in August. Despite the bigger-than-expected rise in the CPI, falling commodity prices have helped to alleviate price pressures in the U.K., which lead the Bank of England to join the Fed and ECB in a coordinated rate cut on October 8th, and unexpectedly lowered the benchmark mark interest rate by half a percent to 4.50%. The surprising move by the central bank indicates that the MPC has shifted their focus to the downside risks for growth, and suggests that price pressures may fall even lower over the coming months as Europe's second largest economy heads into a recession. Fading growth prospects paired with cooling inflation suggests that the BoE may lower borrowing costs further as growth fears intensify.
The U.K. consumer price index rose at a record pace in August as it reached 4.7% from 4.4% in July, which was slightly higher than the 4.6% clip expected by economists. Rising prices pressures have been an ongoing concern for the BoE, but the central bank could be forced to switch gears as the U.K. economy teeters on the brink of a recession. Fading growth prospects paired with the slowdown in the global economy has led market participants to raise bets that the central bank will deliver a rate cut in the coming months as the economy failed to grow in the second quarter. Indeed, falling oil prices are anticipated to curb upside price pressures in the following months, which allot the BoE more room to target downside growth risks in the following months
July 2008 U.K. Consumer Prices
Consumer price growth in the U.K. surged to 4.4% from 3.8% in June, holding well above the central bank's 3% limit for the third consecutive month. Indeed BoE Governor Mervyn King will have to write his third letter of explanation to the Chancellor of the Exchequer, Alistair Darling, and faces an ever-worsening situation as upside prices pressures continue to accelerate amid fading growth prospects. Mounting price pressures will pose an ongoing threat for Europe's second largest economy as consumers face higher living costs amid falling home values. The dour outlook suggests that the central bank will be forced to sit on the sideline once again as they continue to carry out the dual mandate of sustaining economic growth while maintaining price stability.
How To Trade This Event Risk
Inflation in the U.K. is anticipated to pull back from a record high as economists forecast the consumer price index to fall to 4.8% from 5.2% in September. Falling commodity prices should certainly help to lower price pressures in Great Britain as crude oil prices continue to hold below $60 a barrel, and may lead the Bank of England to hold a dovish outlook over the coming months as economic activity slows at a record pace. Europe's second largest economy contracted for the first time in 16 years as GDP declined 0.5% in the third quarter, and led the BoE to lower the benchmark interest last month by a whopping 150bp to 3.00% from 4.50%. With the key rate at its lowest level since 1955, market participants expect the extraordinary efforts by the central bank to pass into the real economy, which should help to boost economic activity going forward. However, the MPC noted that inflationary risks have 'shifted decisively to the downside' following the policy meeting on November 6th, and highlighted that the larger-than-expected reduction 'was necessary' to meet the 2% target' for inflation. Alleviating prices pressures paired with deteriorating fundamentals suggests that Governor Mervyn King will continue to hold a dovish outlook well into the next year, which could drag the British pound lower over the near-term as market participants expect the BoE to remain focused on the downside risks for growth. Moreover, Credit Suisse overnight index swaps are showing that investors expect the MPC to lower the interest rate by nearly 100bp over the next 12 months as the growth outlook turns increasingly bleak. In addition, as fears of a global recession intensify, buying pressures for the Sterling may remain subdued over the near-term as risks sentiment continues to drive price action for the currency market.
As the Bank of England remains focused on growth, we would need a significant rise in the CPI to consider a possible bullish pound trade following the given event risk. Therefore, a reading above the record high of 5.2% would set the stage for a long GBPUSD trade, and we will look for a green, five-minute candle following the release to confirm entry on two lots of the pound-dollar. We will place our initial stop at the nearby swing low (or reasonable distance), and our initial target will be set equal to this risk. Our second target will be base on discretion, and in order to preserve our profits, we will move the stop on the second lot to breakeven once the first trade reaches its target.
On the other hand, an inline print or an inflation reading below 4.8% would only support the dovish outlook held by the MPC, and may weigh on the British pound over the near-term. As a result, declining price pressures would certainly favor a short GBPUSD trade, and we will follow the same setup for the short as the long trade listed above, just in reverse.
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