GBP/USD: Trading The U.K. Consumer Price Report

By David Song, Currency Analyst

Trading the News: U.K. Consumer Price Index

What’s Expected:

Time of release: 01 / 17 / 2012 9 : 30 GMT, 4 : 30 EST

Primary Pair Impact : GBP USD

Expected: 4.2%

Previous: 4.8%

DailyFX Forecast: 4.0% to 4.5%

Why Is This Event Important:

Consumer prices in the U.K. are projected to increase at an annualized rate of 4.2% in December after expanding 4.8% the month prior, and the slower rate of inflation is likely to weigh on the British Pound as we expect the Bank of England to ease monetary policy further in 2012. As the BoE sees an increased risk of undershooting the 2% target for inflation, easing price pressures should lead the central bank to ramp up its asset purchase program, and the Monetary Policy Committee may endorse a dovish outlook for monetary policy as the region teeters on the brink of a double-dip recession. However, should the CPI report top market expectations, the stickiness in price growth may lead the BoE to maintain its current policy stance throughout the first-quarter, and the development may prop up the sterling as market participants scale back expectations for more quantitative easing.

Recent Economic Developments

The Upside

Release

Expected

Actual

Average Weekly Earnings ex Bonus (3MoY) (OCT)

1.7%

1.8%

Producer Price Index - Input (YoY) (NOV)

12.9%

13.4%

Producer Price Index - Output (YoY) (NOV)

5.3%

5.4%

The Downside

Release

Expected

Actual

BRC Shop Price Index (YoY) (DEC)

--

1.7%

GfK Consumer Confidence Survey (DEC)

-32

-33

Retail sales ex Auto Fuel (MoM) (NOV)

-0.4%

-0.7%

Elevated input costs paired with the stickiness in wage growth may push U.K. firms to increase consumer prices, and an above-forecast print may lead the GBP/USD to work its way back towards the 38.2% Fibonacci retracement from the 2009 low to high around 1.5680-1.5700 as the data dampens the prospects for additional monetary support. However, businesses in Britain may absorb higher costs in light of the ongoing weakness within the real economy paired with the slowdown in private sector consumption, and a soft inflation report could spark a sharp selloff in the exchange rate as market participants raise bets for more QE. In turn, the 50.0% Fib (1.5270-1.5300) may give way, and we may see the exchange rate fall back towards 1.5000 to test for psychological support.

Potential Price Targets For The Release

How To Trade This Event Risk

Expectations for a slower rate of inflation casts a bearish outlook for the sterling, but an above-forecast print could set the stage for a long British Pound trade as market participants scale back bets for additional monetary support. Therefore, if the CPI expands 4.5% or greater in December we will need to see a green, five-minute candle following the release to establish a buy entry on two-lots of GBP/USD. Once these conditions are fulfilled, we will place the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk generate our first target. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to lock-in our profits.

However, as the slowing recovery in the U.K. dampens the outlook for inflation, the CPI may reflect a marked deceleration in price growth, and a dismal report could trigger a sharp selloff in the exchange rate as market participants ramp up expectations for more quantitative easing. As a result, if price growth slips below 4.2%, we will implement the same strategy for a short pound-dollar trade as the long position mentioned above, just in the opposite direction.

Impact that the U.K. Consumer Price report has had on GBP during the last month

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

NOV 2011

12/13/2011 9:30 GMT

4.8%

4.8%

+6

-99

November 2011 U.K. Consumer Price Index

The headline reading for U.K. inflation increased at an annual rate of 4.8% in November, which compares to the 5.0% expansion the month prior, while core consumer prices advanced 3.2% during the same period amid forecasts for a 3.3% print. During the month, prices for clothing and footwear advanced 1.2%, with the cost for food and beverages climbing 0.6%, while transportation costs slipped another 0.6% after contracting 0.7% in October. As the slowing recovery in the U.K. bears down on price growth, we expect the Bank of England to carry its easing cycle into the following year, and the central bank may see scope to further expand its balance sheet as policy makers see an increased risk of undershooting the 2% target for inflation. The British Pound gained ground following the report, with the GBP/USD pushing above 1.5600, but the sterling struggled to hold its ground during the North America trade as the pair ended the day at 1.5476.

--- Written by David Song, Currency Analyst