GBP/USD: Trading the U.K. Producer Price Index

Trading the News: U.K. Producer Price Index Output

What's Expected

Time of release: 12/08/2008 09:30 GMT, 04:30 EST
Primary Pair Impact : GBPUSD
Expected: 5.6%
Previous: 6.8%

Impact the U.K. PPI Output has had on GBPUSD after the last 3 releases

October 2008 U.K. Producer Price Index Output

he U.K.'s producer price index fell at a record pace in October, which lowered the annual rate of inflation to 6.8% from 8.5% in September. The breakdown of the report showed that petrol prices fell 5.6% from the previous month, while core prices slipped 0.5%. The data suggests that firms will continued to cut prices as Europe's second largest economy heads into its worst recession since 1991, and has certainly raised the risks for deflation as the Bank of England expects inflation to fall below the 2% target. Falling commodity prices paired with deteriorating fundamentals led the BoE to aggressively lower borrowing costs throughout the second half of the year, and may continue to ease policy next year to carry out their dual mandate to ensure price stability while fostering economic growth.

September 2008 U.K. Producer Price Index Output

Factory-gate prices in the U.K. dropped for the second consecutive month in September as economic activity weakened throughout the second half of the year. The producer price index slipped to 8.5% from a revised reading of 9.1% in August on the back of falling commodity prices, and should allow the Bank of England to lower borrowing costs further as the economy heads into a recession. The MPC voted unanimously cut the benchmark interest rate by 50bp in a coordinated effort to restore confidence in the financial market, and lowered the rate to 4.50% from 5.00%. Easing price pressures paired with fears of a significant economic downturn has already stoked expectations that the BoE will continue to cut borrowing costs in the near-term, which could weigh on the British pound going forward.

August 2008 U.K. Producer Price Index Output

U.K. producer prices unexpectedly declined for the first time in nearly a year due to a significant pullback in commodity prices. The PPI slipped to 9.7% from 10.2% in the previous month, which suggests that inflation may have peaked during July. Easing prices pressures will certainly allow the Bank of England to shift their focus to growth and push inflationary concerns to the backburner, which leaves the door open for a potential rate over the coming months as growth prospects for the U.K. deteriorate. Meanwhile, the MPC continued to hold a neutral policy stance as they voted to hold the interest rate at 5.00% during the September 4th meeting, while Chancellor Alistair Darling explicitly stated that Great Britain may face the worst economic downturn since the 1940's.

How To Trade This Event Risk

Price pressures in the U.K. are expected to weaken further as economists forecast the producer price index to fall to 5.6% from 6.8% in October. The remarkable slowdown in the economy paired with falling commodity prices allowed firms to aggressively lower output prices throughout the second half of the year, and may continue to cut prices over the coming months as the economy heads into its worst recession since 1991. Europe's second largest economy contracted 0.5% in the third quarter as private-sector consumption fell for two consecutive quarter, and was followed by a 2.4% drop in business investments. In addition, retail spending contracted for the second straight months in October, which suggests that firms will continue to lower prices in order to stay afloat during the considerable downturn in the economy. Meanwhile, the Bank of England continued to highlight the risks for deflation as he saw a ‘substantial risk' for inflation to fall below the 2% target, which could lead the central bank to lower borrowing costs even further as policymakers carry out their dual mandate to ensure price stability while fostering economic growth. Moreover, Credit Suisse overnight index swaps are showing that investors expect the BoE to lower rates further over the next 12 months, which could stoke increased selling pressures for the British pound over the near-term.

As the Bank of England continues to hold a dovish outlook, we would need to see a considerable spike in inflation to set the stage for a long pound-dollar trade. As a result, a PPI reading above 6.8% would favor a bullish outlook for the British pound, and we will look for a green, five-minute candle following the release 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 purely on our discretion, and once the first lot reaches its target, we will move the stop on the second lot to breakeven in order to preserve our profits.

However, as the headline CPI reading fell at a record pace to lower the annual rate of inflation to 4.5% from 5.2%, the chances for rise in the PPI remains dim. Therefore, an inline print or an inflation reading below 5.6% would favor a short GBPUSD trade, and we will follow the same setup as the long trade listed above, just in reverse.

DailyFX

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