Trading the News: UK Retail Sales

What's Expected:

Time of release: 02/20/2009, 09:30 GMT (04:30 EST)
Primary Pair Impact: GBP/USD
Expected: -0.1%
Previous: 1.6%

Effect the UK Retail Sales Report Had Over EUR/USD for the Past Two Months

December 2008 UK Retail Sales
Private sector spending in the UK unexpectedly increased 1.6% in December, however, the statistics office explicitly stated that the data should be interpreted with a grain of salt as they re-evaluate their standards for measuring seasonal changes. Nevertheless, the breakdown of the report showed that sales at food stores rose 1.0% during the month, which was followed by a 0.5% rise in demands for household goods, while discretionary spending for clothing and shoes slipped 0.8% from the previous month. Despite the rise in sales, the outlook for growth remains bleak as the economy faces a deepening recession, and the Bank of England is likely to lower rates further next month in an effort to stimulate the ailing economy.

November 2008 UK Retail Sales
Retail spending in Britain rose 0.3% in November amid expectations for a 0.6% decline, however, economic activity is likely to deteriorate over the coming months as the outlook for future growth remains bleak. A deeper look at the report showed that demands for household goods rose 3.9% after dropping 3.6% in October, while discretionary spending on clothing and footwear slipped another 0.1% after falling 1.0% in the previous month. Despite the enhanced sales reading, the Bank of England is widely expected lower the benchmark interest rate by 50bp to 1.50% in January as the economy heads into a deeper recession, which would be the lowest level since the central bank was established in 1694.

What to Look for Before the Release
Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market's directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the bid versus the offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:
If we see substantially deeper available liquidity on the bid side of the market, this tells us that major price providers in the market are looking to buy the pound against the US dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions, and will favor a bullish bias on GBP/USD ahead of the data release.

Bearish Scenario:
If we see substantially deeper available liquidity on the offer side of the market, this tells us that major price providers in the market are looking to sell the pound against the US dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions, and will favor a bearish bias on GBP/USD ahead of the data release.

How to Trade This Event Risk |pagebreak|

Retail spending in the UK is anticipated to fall 0.1% in January as households face a weakening labor market, and a dismal sales reading would only reinforce the dour outlook held by the IMF as they expect Europe's second largest economy to face its worst economic slump since World War II. The advanced GDP reading showed that the region posted its biggest economic contraction since 1980 as the annual rate of growth slipped to -1.8% from 0.3% in the third quarter, which was led by a 4.6% drop in manufacturing paired with a 1.0% contraction in service-based activity, and the data foreshadows a deepening recession in the country as firms continue to aggressively cut back on production and employment in an effort to reduce costs. As a result, jobless claims in the UK rose to a ten-year high of 1.23M in January as 73.8K additional workers filed for unemployment benefits during the month, raising the annualized figure to 3.8% from 3.6% in December. Furthermore, a separate report by the International Labor Organization showed that the unemployment rate rose to 6.3% from 6.1% in November, which is the highest level since 1997, and conditions are likely to get worse as the Bank of England forecasts the annual rate of growth to contract 4.0% in the first quarter amid the extraordinary efforts taken on by policymakers.

The central bank said that "further easing in monetary policy may well be required" even after lowering the benchmark interest rate to a record low of 1.00% earlier this month, and as price growth is projected to reach 0.5% by the end of 2010, the MPC is likely to step up their efforts as they maintain their dual mandate to ensure price stability while fostering economic activity. Meanwhile, the BOE minutes released recently showed that the board voted unanimously to adopt quantitative easing to better manage monetary policy, and reports have been made that Mr. King has already asked the Chancellor of the Exchequer, Alistair Darling, for additional authority to begin printing money to purchase "government and other" assets to stimulate the economy. As BOE Governor Mervyn King and company implement unconventional means to steer the economy out of a recession, the efforts by the central bankers will certainly help to mitigate the downside risks for growth, but as the global economy slips into a deepening recession, the odds for a marked recovery this year remain highly unlikely.

Trading the given event risk may not be as a clear cut as some of our other trades, but if we see a surprising increase in private spending, as we did in the previous month, a rise of 0.1% or more in sales would certainly set the stage for a long pound trade. Therefore, with our expectations at hand, we will look for a green, five-minute candle following a rise in retail sales to confirm a buy entry on two lots of GBP/USD. Once these conditions are met, we will place our initial stop at the nearby swing low (or a reasonable distance taking volatility into consideration), and this risk will determine our first target.

On the other hand, as governor Mervyn King expects "a pronounced contraction in spending and outputs" this year, a dismal sales reading would only reinforce a dour outlook for the economy, and will favor a bearish outlook for the British pound. As a result, if household spending falls 0.1% or more, we will look to sell GBP/USD, and will follow the same strategy for the short position as the long trade listed above, just in reverse.