UK Inflation Surprise Could Offer Volatility

UK Inflation Surprise Could Offer Volatility

British inflation expectations and prints have been unstable since Brexit vote. A CPI reading below expectations this week combined with a stronger Yen could drive a volatile ride in GBPJPY.

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Binary options traders will closely monitor the inflation data flow from the United Kingdom this week, as it will offer a potential opportunity for increased volatility and price action. We encourage traders to develop a point of view on the data, and use that to inform a potential binary trading strategy for the week.

The UK will report July inflation at 8:30 GMT on Tuesday, August 15th.

Last month, inflation in the UK surprised markets by slowing considerably. At the time, last month’s CPI print effectively eliminated any lingering hopes for a hike from the Bank of England’s (BoE) at last month’s blockbuster Super Thursday event.


 

In the previous month of May, inflation had risen to the multi-year high of 2.9%. Last month produced a 2.6% print. This produced a whipsaw effect in relation to expectations as the May number ended up being well beyond expectations, and last month’s dip was well under. When last month's number was released on July 18th, this caused a major move in the price of the Pound offering binary traders the potential to stake out positions on either side of the price range in an effort to effectively buy the volatility. The chart below shows the dip in price when the data was released with an Average True Range indicator to show the magnitude of the overall swing.

 

 

According to the BoE and Governor Mark Carney, the main driver for the rise in inflation had been the precipitous drop in the value of Pound Sterling following last fall’s Brexit vote. This explanation makes logical sense, and you can see it play out in a chart of the inflation rate since the financial crises.

 

 

Last fall, the Pound took a wild and steep dive after the vote. After several further corrections downward, the currency has passed through a period of consolidation moves and now we have seen Sterling exit the consolidation zone and establish the structure of a move higher. 

 

 

This relatively modest recovery should apply a subtle amount of downward pressure on core inflation. While Pound Sterling has only recovered a fraction of the value it lost as a result of the Brexit vote, any lift should roll through the broader economy. If we attribute a spike in CPI to a fall in the Pound, it logically follows a recovering Pound should have the inverse effect. A moderately recovering Pound, conflated with a larger slowdown in inflation globally, provides a basis for an outlook for a slightly lower CPI this month versus last.

Below is the result of an econometric forecast model tuned for a sensitivity to seasonality and current economic conditions. It provides guidance for a 2.45% reading this month, and for a slow climb to 3% by the end of the year. Broad market expectations for this month are 2.7%.

 

 

A reading below expectations could have outsized impact on the Yen / Pound Sterling pair. The pair moved to a critical threshold late last week as it threatened a downside break on a long running trendline dating to last October. A strengthening Yen that is attractive in a risk off environment conflated with a weakening Pound due to slowing inflation could add additional velocity this week for binary traders to what is already known as a highly volatile cross.

 

 

Our base case for the data on Tuesday is a reading below market expectations, which is 2.7%. The further below 2.7% the reading is will determine the downward impact on the Sterling / Yen pair. A reading in the 2.4% - 2.6% range would further accelerate the downside trend bias below the structure of the current trendline and bring the 140.00 value into play. The next meaningful level below 140.00 is 138.90 and we could see several tests of that level by the end of the week.

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