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

The small rebound in the GBP/USD may gather pace over the next 24-hours of trading as the headline reading for U.K. inflation is forecasted to increase at an annualized rate of 4.1% in April, and the faster pace of price growth could lead the exchange rate to work its way back towards 1.6400 as investors speculate the Bank of England to start normalizing monetary policy in the second-half of 2011.

Trading the News: U.K. Consumer Price Index

What's Expected:

Time of release: 05/17/20118:30 GMT, 4:30 EST

Primary Pair Impact: GBPUSD

Expected: 4.1%

Previous: 4.0%

DailyFX Forecast: 4.0% to 4.2%

Why Is This Event Important:

The small rebound in the GBP/USD may gather pace over the next 24-hours of trading as the headline reading for U.K. inflation is forecasted to increase at an annualized rate of 4.1% in April, and the faster pace of price growth could lead the exchange rate to work its way back towards 1.6400 as investors speculate the Bank of England to start normalizing monetary policy in the second-half of 2011. According to Credit Suisse overnight index swaps, market participants see borrowing costs in Britain increasingly at least 25bp over the next 12-months, and the BoE may toughen its stance against inflation as policy makers forecast CPI inflation reach an annualized 5.0% this year. In turn, Governor Mervyn King may adopt a hawkish tone in the meeting minutes due out on May 18th, and policy statement could reveal a growing shift thin the MPC as the central bank maintains its dual mandate to ensure price stability while fostering full employment.

Recent Economic Developments

The Upside

Release	Expected	Actual
Producer Price Index Output (YoY) (APR)	5.1%	5.3%
Gross Domestic Product (QoQ) (1Q A)	0.5%	0.5%
Retail Sales ex Auto Fuel (MoM) (MAR)	-0.4%	0.2%

The Downside

Release	Expected	Actual
Nationwide House Prices s.a. (MoM) (APR)	0.1%	-0.2%
Net Consumer Credit (MAR)	0.6B	0.1B
GfK Consumer Confidence Survey (APR)	-27	-31

As the region skirts a double-dip recession, businesses may rein in on discounting and raise prices for consumers as private sector spending improves. However, as households sentiment deteriorates, the ongoing weakness in the real economy may lead businesses to absorb higher costs, and a slower pace of inflation would certainly dampen speculation for a BoE rate hike as the central bank curbs its outlook for future growth. As the majority of the MPC maintains a neutral policy stance, the committee may carry its wait-and-see approach into the second-half of the year, and the British Pound may continue to retrace the advance from earlier this year as interest rate expectations deteriorate.

Potential Price Targets For The Release

How To Trade This Event Risk

Forecasts for a faster pace of inflation certainly encourage a bullish outlook for the sterling, and the market reaction following the report could set the stage for a long British Pound trade as the BoE sees a higher risk for inflation. Therefore, if the CPI increases at an annualized pace of 4.1% or greater in April, we will need a green, five-minute candle subsequent to the data to generate a buy entry on two-lots of GBP/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance after taking market volatility into account, and this risk will establish 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 protect our profits.

On the other hand, firms in the U.K. may look to absorb higher input costs give the substantial margin of slack within the real economy, and the BoE may uphold its current policy stance throughout the third-quarter as it aims to encourage a sustainable recovery. In turn, if the headline reading for inflation holds steady at 4.0% or unexpectedly weakens from the previous month, we will implement the same strategy for a short pound-dollar trade as the long position laid out above, just in reverse.

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)
Mar 2011	04/12/2011 8:30 GMT	4.4%	4.0%	-74	-55

March 2011 U.K. Consumer Price Index

The headline reading for U.K. inflation increased at an annualized pace of 4.0% in March to mark the slowest pace of growth since January, while core consumer prices grew 3.2% from the previous year amid forecasts for a 3.3% print. The breakdown of the report showed food prices weakened 1.0% during the month, with cost of housing slipping 0.1%, while prices for clothing and footwear increased another 2.5% after expanding 8.0% in February. As price growth cools, the slower pace of inflation would certainly allow the Bank of England to retain its wait-and-see approach throughout the first-half of the year, and Governor Mervyn King may continue to talk down speculation for higher borrowing costs in the U.K. given the ongoing weakness in the real economy. Indeed, the British Pound weakened following the slower pace of inflation, with the GBP/USD slipping to a fresh daily low of 1.6226, but the sterling recouped some of its losses during the North American trade as the exchange rate settled at 1.6254.

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To discuss this report contact David Song, Currency Analyst: dsong@dailyfx.com