Trading the News: Bank of England Rate Decision

What's Expected

Time of release: 01/08/2009 12:00 GMT, 07:00 EST
Primary Pair Impact : GBPUSD
Expected: 1.50%
Previous: 2.00%
Impact the Bank of England Rate Decision has had on GBPUSD after the last 3 releases

December 2008 Bank of England Rate Decision

BoE Governor Mervyn King and Co pushed borrowing costs to its lowest level since 1951 as they voted unanimously to cut the benchmark interest rate by 100bp to 2.00%. The minutes of the rate decision showed that the MPC considered an even larger reduction in the key rate in order to meet their dual mandate to ensure price stability while fostering economic growth, but concerns of an 'excessive' drop in the U.K. currency lead policymakers to hold off from such an aggressive move as it would 'undermine confidence in the economy more widely,' the MPC said. Moreover, the BoE stated that rates may have to go lower as they perceive significant 'downside risk to inflation,' and went on to say that 'without further policy action, inflation would substantially undershoot the target in the medium term.'

November 2008 Bank of England Rate Decision

U.K. policymakers voted 9-0 to lower the benchmark interest rate by 150bp to 3.00%, but considered an even larger cut as the headline reading for inflation fell at a record pace in October. Falling oil prices paired with the significant slowdown in the economy lowered consumer prices to an annual growth rate of 4.5% from 5.2% in September, with policymakers forecasting price growth to fall 'well below' the central bank's 2% target in 2009, which would lead the BoE to continue their easing cycle over the coming months. Governor Mervyn King noted that he is ready and willing to lower borrowing costs to 'whatever level is necessary' in order to meet the bank's dual mandate, which supports the MPC's argument that rates will have to fall lower as Europe's second largest economy faces its worst recession in over a decade.

October 2008 U.K. Bank of England Rate Decision

The Bank of England surprised the markets by joining the Fed and ECB in a coordinated rate cut on October 8, and voted unanimously to lower the benchmark interest rate by 50bp to 4.50% as the U.K. economy teeters on the brink of a recession. BoE Governor Mervyn King stated that the spillover effects from the global credit crunch has raised the risks of a 'sharp and prolonged' economic downturn, and went onto say that it 'seems likely' that the economy will slip into a recession in 2008. The drastic downturn in the economy paired with falling commodity prices allowed the MPC to hold a dovish outlook for inflation, and the central bank is widely expected to step up their efforts over the coming months in order to maintain price stability. Moreover, the BoE noted that the risks for inflation have 'shifted decisively to the downside,' and said that the bank 'will act promptly' in order to maintain their 2% target for inflation.

How To Trade This Event Risk

Expectations for lower borrowing costs could weigh on the British pound as economists anticipate the Bank of England to cut the benchmark interest rate by another 50bp to 1.50%, which would be the lowest since the central bank was given the authority to set interest rate policy in 1870. As Europe's second largest economy faces its worse recession in over a decade, policymakers are expected to step up their efforts in response to the biggest economic contraction since 1990. The final 3Q GDP reading showed that economic activity dropped 0.6% from the previous quarter, and the outlook for growth remains bleak as the National Institute for Economic and Social Research expects GDP to contract by more than 1% in the fourth quarter. In addition to the dour outlook, business investments fell 1.3% in the third quarter, which suggests that firms will continue to cutback on production and spending as demands from the global economy falter. Deteriorating fundamentals paired with fading employment opportunities pushed jobless claims to an 8-year high of 1.07M as the number of workers who filed for unemployment benefits rose 75.7K in November. Despite the extraordinary efforts taken on by policymakers, economic activity will remain subdued throughout the first half of 2009 as the labor market weakens given the significant downturn in the global economy, which could lead the MPC to lower the interest rate to zero as they make every effort to safeguard the economy from a hard landing. Moreover, as the BoE forecasts price growth to fall below the 2% target for inflation, policymakers will also be inclined to ease policy further in order to carryout their mandate to ensure price stability.

Setting up a long pound trade for the given event risk may not be as clear cut as some of our other trades, but nevertheless, if the Bank of England decides to cut less than 50bp or opts to suspend their easing cycle, investors would adjust their interest rate outlook for the U.K., which could trigger a rally in pound-dollar. With our expectations at hand, we will look for a green, five-minute candle following the release to confirm entry on two lots of GBPUSD. Our initial stop will be placed at the nearby swing low (or reasonable distance), and this risk will determine our first target. Our second target will be based on discretion, and in order to preserve our profits, we will move the stop on the second lot to breakeven once the first lot reaches its target.

On the other hand, mounting growth concerns paired with the rising risk for deflation reinforces the arguments made by BoE Governor Mervyn King for lower borrowing costs, and 50bp+ rate cut paired with dovish commentary would solidify a bearish outlook for the British pound. Therefore, if the central bank reinforces their outlook for lower inflation and lowers the benchmark interest rate to at least 1.50%, we will follow the same strategy for a short position as the long trade listed above, just in reverse.