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

The Bank of England is widely expected to hold the benchmark interest rate at 0.50% while maintaining its asset purchase target at GBP 200B, but currency traders may show a bearish reaction to the announcement as interest rate expectations deteriorate.

Trading the News: Bank of England Interest Rate Decision

What's Expected:

Time of release: 05/05/2011 11:00 GMT, 7:00 EST

Primary Pair Impact: GBPUSD

Expected: 0.50%

Previous: 0.50%

DailyFX Forecast: 0.50%

Why Is This Event Important:

The Bank of England is widely expected to hold the benchmark interest rate at 0.50% while maintaining its asset purchase target at GBP 200B, in May, but currency traders may show a bearish reaction to the announcement as interest rate expectations deteriorate. According to Credit Suisse overnight index swaps, market participants are pricing a 7% chance for a 25bp rate hike in May, and see borrowing costs increasing by 25bp over the next 12-months amid earlier projections for a 50bp rise in April. In light of the recent comments from BoE Governor Mervyn King, the majority of the MPC is likely to uphold their wait-and-see approach going into the second-half of the year, and the central bank head may continue to strike a dovish outlook for future policy given the ongoing weakness within the real economy.

Recent Economic Developments

The Upside

Release	Expected	Actual
GDP (QoQ) (1Q A)	0.5%	0.5%
Retail Sales ex Auto Fuel (MoM) (MAR)	-0.4%	0.2%
Nationwide Consumer Confidence (MAR)	40	44

The Downside

Release	Expected	Actual
Mortgage Approvals (MAR)	48.0K	47.6K
Jobless Claims Change (MAR)	-3.0K	0.7K
Consumer Price Index (YoY) (MAR)	4.4%	4.0%

As the U.K. skirts a double-dip recession, the rebound in private sector consumption paired with the ongoing improvement in consumer confidence could lead the BoE to hold an improved outlook for the region, and the central bank may show an increased willingness to start normalizing monetary policy later this year as the recovery gather pace. However, the ongoing weakness in the housing market paired with the slower rate of price growth could lead the BoE to retain a neutral policy stance for most of 2011, and the central bank may continue to talk down speculation for higher interest rates as it aims to encourage a sustainable recovery. As we expect the BoE to refrain from releasing a policy statement, currency traders will certainly turn their focus to the quarterly inflation report due out on May 11, but the British Pound remains at risk to face additional head winds over the near-term as interest rate expectations falter.

Potential Price Targets For The Release

How To Trade This Event Risk

Attempting to trade the Bank of England interest rate decision is certainly not as clear cut as some of our previous trades, but the market reaction following the announcement could pave the way for a long British Pound trade as the region skirts a double-dip recession. Therefore, if the BoE releases a hawkish policy statement or surprises the market with a 25bp rate hike, we will need a green, five-minute candle following the meeting to establish 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 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 protect our profits.

On the other hand, currency traders may show a bearish reaction to the rate decision as the central bank continues to delay normalizing monetary policy, and interest rate expectations may deteriorate further over the near-term as the BoE talks down the risk for inflation. As a result, if the MPC maintains a dovish outlook for monetary policy, we will carry out the same setup for a short pound-dollar trade as the long position laid out above, just in the opposite direction.

Impact that the Bank of England Rate Decision has had on GBP during the last meeting

Period	Data Released	Estimate	Actual	Pips Change (1 Hour post event )	Pips Change (End of Day post event)
Apr 2011	04/07/2011 11:00 GMT	0.50%	0.50%	-34	-13

April 2011 Bank of England Interest Rate Decision

The Bank of England held the benchmark interest rate at 0.50% in April while maintaining its asset purchase target at GBP 200B, but refrained from releasing a policy statement as the central bank continued to carry out its wait-and-see approach. The meeting minutes showed another 6-3 split within the MPC, with Marin Weale and Spencer Dale calling for a 25bp rate hike, while Andrew Sentance saw scope to increase the benchmark interest rate to 1.00% given the stickiness in price growth. The BoE continued to highlight the ongoing weakness within the real economy, noting that a rise in U.K. borrowing costs “could adversely affected consumer confidence, leading to an exaggerated impact on spending, and went onto say that the “substantial margin of spare capacity was likely to persist for some time,” which should dampen the risk for medium-term inflation. Indeed, currency traders showed a bearish reaction to the rate decision, with the GBP/USD slipping back to a low of 1.6262, but the British Pound recouped the losses following the announcement as the exchange rate ended the day at 1.6318.

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