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

The headline reading for U.K. inflation is expected to hold steady at an annualized 4.5% in May, but a slower pace of core price growth could weigh on the British Pound as currency traders scale back speculation for a rate hike later this year.

Trading the News: U.K. Consumer Price Index

What's Expected:

Time of release: 06/14/2011 8:30 GMT, 4:30 EST

Primary Pair Impact:GBPUSD

Expected: 4.5%

Previous: 4.5%

DailyFX Forecast: 4.2% to 4.5%

Why Is This Event Important:

The headline reading for U.K. inflation is expected to hold steady at an annualized 4.5% in May, but a slower pace of core price growth could weigh on the British Pound as currency traders scale back speculation for a rate hike later this year. As the economic recovery in the U.K. cools, the ongoing weakness within the private sector may continue to bear down on consumer prices, and the Bank of England may keep the benchmark interest rate at 0.50% in the second-half of the year as it aims to balance the risks for the region. However, heightening price pressures should help to prop up the sterling as market participants retain bets for a 25bp rate hike in the next 12-months, and the MPC may look to toughen its stance against inflation as policy makers see price growth reaching 5% in 2011.

Recent Economic Developments

The Upside

Release	Expected	Actual
GfK Consumer Confidence Survey (MAY)	-31	-21
Gross Domestic Product (QoQ) (1Q P)	0.5%	0.5%
Retail Sales ex Auto Fuel (MoM) (MAR)	0.8%	1.2%

The Downside

Release	Expected	Actual
Producer Price Index – Output (YoY) (MAY)	5.3%	5.3%
Jobless Claims Change (APR)	0.0K	12.4K
Average Weekly Earnings ex Bonus (3MoY) (MAR)	2.2%	2.1%

As household confidence marks the biggest advance in nearly 18-years, the rebound in economic growth paired with the ongoing expansion in private sector consumption may lead businesses to pass on higher costs onto consumers. However, as the rise in producer prices cool, the ongoing weakness within the economy paired with the slowdown in wage growth may lead firms to keep a lid on prices, and a soft inflation report would certainly allow the BoE to retain the expansion in monetary policy throughout the remainder of the year as it aims to encourage a sustainable recovery. In turn, a slower pace of price growth is likely to weigh on interest rate expectations, and the GBP/USD may make another run at 1.6000 over the near-term as it threatens the rebound from back in May.

Potential Price Targets For The Release

How To Trade This Event Risk

Trading the given event risk is certainly not as clear cut as some of our previous trades, but an unexpected rise in the CPI could set the stage for a long British Pound trade as heightening price pressures raises the prospects of seeing a rate hike later this year. Therefore, if the headline reading for inflation advances at an annual pace of 4.6% or higher in May, we will need to see a green, five-minute candle following 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 from the entry, 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 order to protect our profits.

On the other hand, businesses in Britain may continue to absorb higher costs in order to drive domestic demands, and the BoE may see scope to retain its current policy stance throughout the remainder of the year as it aims to encourage a sustainable recovery. In turn, if the CPI holds steady at 4.5% or unexpectedly weakens from the previous month, we will implement the same setup for a short pound-dollar trade as the long position laid out 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)
Apr 2011	05/17/2011 8:30 GMT	4.1%	4.5%	+42	+1

April 2011 U.K. Consumer Price Index

The headline reading for U.K. inflation increased at an annual pace of 4.5% in April, while the core consumer price index advanced to 3.7% from 3.2% to mark the highest reading since the series began in 1997. Indeed, the above-target inflation forced Bank of England Governor Mervyn King to write a letter of explanation to Chancellor of the Exchequer George Osborne, with the central bank head stating that price growth was being largely driven by higher sales tax and higher energy prices. As price pressures intensify, the central bank is likely to face increased pressures to lift the benchmark interest off of the record-low, and the MPC may see scope to start normalizing monetary policy this year as inflation is expected to reach an annualized 5% in 2011. The higher-than-expected rate of inflation sparked a bullish reaction in the British Pound, with the exchange rate rallying to a fresh daily high of 1.6302, but the sterling struggled to maintain the advance during the day as the GBP/USD settled at 1.6247 at the close.

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