GBP/USD: How to Trade the UK Retail Sales Report

06/18/2009 12:01 am EST

Focus: FOREX

Retail spending in the UK is expected to increase for the third consecutive month in May, with economists forecasting a 0.3% rise from the previous month, and the British pound may continue to strengthen against its currency counterparts over the near term as investors anticipate the Bank of England to tighten policy over the next 12 months.

Trading the News: UK Retail Sales

What’s Expected:
Time of release: 06/18/2009 09:30 GMT, 04:30 EST
Primary Pair Impacted: GBP/USD
Expected: 0.3%
Previous: 0.9%

Effect of Past UK Retail Sales Reports on GBP/USD

April 2009 US Retail Sales
Retail sales in the UK jumped 0.9% in April, topping forecasts for a 0.5% rise, and the data encourages an improved outlook for future growth as the government takes unprecedented steps to shore up the economy. The breakdown of the report showed sales at non-specialized stores increased 3.5% from March, with demands for household goods rising 0.2%, while discretionary spending on clothing and footwear slowed to 0.3% from 0.9% in the previous month. At the same time, BoE governor King said that he expects a “Slow and protracted” recovery as the region faces its worst recession in over half a century, and went on to say: “Inflation is more likely to be below the target than above.” The dovish outlook held by the board suggests that the MPC may expand its asset purchase program in order to jumpstart the economy, and is likely to hold the key rate at the record low for some time as growth and inflation falter.

March 2009 US Retail Sales
Private consumption in the UK unexpectedly increased 0.3% in March, which pushed the annualized reading to 1.5% from 0.4% in the previous month. A deeper look into the report showed discretionary spending on clothing and footwear increased 1.5% from the previous month, followed by a 0.6% rise in food store sales, while demands for household goods dropped 2.0% during the month. The data suggests households are turning less pessimistic towards the economy as policymakers take unprecedented steps to shore up the island nation, however, conditions are likely to get worse as the region faces its worst economic downturn in over half a century. As a result, the Bank of England increased its asset purchase program by GBP 50B to a total of GBP 125B earlier this month, and may utilize the remaining GBP 25B in the second half of the year as growth and inflation falter.

What to Look for Before the Release

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 that 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.

NEXT: How to Trade This Event Risk |pagebreak|

Retail spending in the UK is expected to increase for the third consecutive month in May, with economists forecasting a 0.3% rise from the previous month, and the British pound may continue to strengthen against its currency counterparts over the near-term as investors anticipate the Bank of England to tighten policy over the next 12 months. At the same time, David Blanchflower, a former member of the MPC, anticipates jobless claims to average 100K per month “For the next year or so,” and the downturn in the labor market is likely to weigh on household spending as the region faces its worst recession in over half a century. The preliminary GDP reading for the UK showed economic activity fell at its fastest pace since 1979 during the first quarter, driven by a downturn in private spending and business investments, while a report by the British Retail Consortium showed sales grew at a slower pace in May, with same store sales slipping 0.8% for the previous month. In addition, a separate report by the National Statistics Office showed consumer prices rose at an annual pace of 2.2% during the same period, led by higher taxes on alcohol and tobacco, while the Local Government Association said claims for unemployment benefits for white-collar employees jumped 154% in May over the previous year as a result of the worst financial crisis since the Great Depression. Meanwhile, BoE governor Mervyn King said that he anticipates a “Slow and protracted recovery” next year as domestic demands falter, and expectations for higher unemployment foreshadow a weakening outlook for private consumption as households face “sticky” prices along with fears of a deepening recession. At the same time, the National Institute of Economic and Social Research reported the growth rate contracted at a slower pace in the three months though May, while consumer credit unexpectedly increased 0.3B in April, and growth prospects may continue to improve as policymakers take unprecedented steps to soften the landing of Europe’s second largest economy. Nevertheless, the BoE minutes for the May policy meeting said some members of the MPC made arguments to increase the asset purchase program by GBP 75B instead of GBP 50B, while the board lowered its outlook for inflation, forecasting prices to grow at an annual rate of 0.4% this year. As the MPC projects inflation to hold below the 2% target rate until 2012, speculation for further easing may weigh on the exchange rate over the medium term, however, as market sentiment improves, the rise in risk appetite could lead the British pound higher against its currency counterparts.

Expectations for a third consecutive monthly rise in retail sales favors a bullish outlook for cable, and price action following the release could set the stage for a long GBP/USD trade. Therefore, an in-line print or a rise greater than 0.3% would lead us to look for green, five-minute candles subsequent to the release 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 reasonable distance), and this risk will establish our first target. Our second target will be based on discretion, and in an effort to preserve our profits, we will move the stop on the second lot to break even once the first trade reaches its target.

In contrast, fears of a protracted downturn paired with fading demands for employment may lead consumers to cut back on spending, and an unexpected drop in domestic demands is likely to weigh on the exchange rate as growth prospects falter. As a result, a drop of 0.2% or more would lead us to favor a bearish outlook for cable, and we will follow the same strategy for a short GBP/USD trade as the long position mentioned above, just in reverse.

By David Song, Currency Analyst, DailyFX.com

 

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