Trading the News: Bank of England Rate Decision

What's Expected

Time of release: 02/05/2009 12:00 GMT, 07:00 EST

Primary Pair Impact : GBPUSD

Expected: 1.00%

Previous: 1.50%

Impact the Bank of England Rate Decision has had on GBPUSD after the last 3 releases

January 2009 Bank of England Rate Decision

The Bank of England voted 8-1 to cut the benchmark interest rate by 50bp to 1.50%, which is the lowest level since the central bank was established in 1694. The minutes of the policy meeting showed that the central bank dove David Blanchflower went against the majority as he pushed for a 100bp cut, but the MPC opted for a half-point reduction in order to avoid shocks 'in both financial markets and the real economy.' Despite the extraordinary efforts taken on by the central bank and Prime Minister Gordon Brown, the growth outlook for the U.K. remains bleak as fundamentals deteriorate at a record pace, and conditions are likely to only get worse as Europe's second largest economy heads into its worst recession in over a decade. Nevertheless, the BoE noted that the outlook for inflation 'remained to the downside' as economic activity falters, and may continue to ease policy further in order to maintain their 2% target for price growth.

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 U.K. 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.

How To Trade This Event Risk

The British pound may face increased selling pressures over the next 24 hours of trading as market participants forecast the Bank of England to lower the benchmark interest rate by another 50bp to 1.00%, which would be the lowest level in the central bank's history. A Bloomberg News survey shows that 56 of the 61 economists polled expect the central bank to cut borrowing costs to 1.00% however, as investors expect the BoE to conclude its easing cycle this month, long-term expectations for higher rate could push the Sterling higher following the rate decision. Nevertheless, as the International Monetary Fund expect the U.K. to face a deepening recession and projects the economy to contract 2.8% this year, deteriorating fundamentals paired with financial uncertainties will continue to drag on the outlook for growth and may lead policy makers to ease policy further as Europe's second largest economy heads into its worst recession since World War II. The advanced GDP reading for the fourth quarter showed that economy contracted another 1.5% after falling 0.6% in the previous quarter, and conditions are likely to only get worse as the National Institute of Economic and Social Research anticipates the economy to contract until the fourth quarter, and forecasts the annual rate of growth to fall 2.7% in 2009. Economic activity throughout the region has weakened considerably throughout the second half of 2008 as jobless claims in the U.K. surged to an eight year high of 1.16M during the year, which pushed the annual rate of unemployment rate to 3.6% from 3.3% in November. As a result, consumer confidence fell to a record low in January as the Nationwide index slipped to 40 from a revised reading of 48 in the previous month, and as households become increasingly pessimistic towards the economy, the outlook for improved growth remains bleak. Consequently, the MPC may lower borrowing costs further in an effort to stimulate the economy, and is likely to adopt a zero interest rate policy over the near-term in order to avoid a deepening recession.

Trading the given event risk clearly favors a bearish forecast for the British pound and may not be as clear cut as some of our other trades, but as market participants expect the Bank of England to conclude its easing cycle, investors are likely to adjust their interest rate outlook for the U.K., which could trigger a rally in the pound-dollar. Therefore, if the MPC delivers a 50bp cut and states that they will keep rate on hold for the foreseeable future, we will look for a green, five-minute candle following the decision to confirm entry on two lots of GBPUSD. We will place our initial stop 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 is likely to weigh on the economic outlook, which could lead BoE Governor Mervyn King and Co to drag borrowing costs below 1.00% over the coming months. As a result, if the central bank reinforces their outlook for lower inflation and holds a dour outlook for future growth, the British pound is likely to face increased selling pressures following the decision, and we will follow the same strategy for a short trade as the long position listed above, just in reverse.