Is QE on the horizon for the British pound?

The British pound has dropped about 5% in the past 15 trading days, rivaling one of its worst declines back in September 2011. It recently fell to a three-year low at $1.4811 after reports of a 0.8% decrease in industrial production during May with virtually no change in production since then. The results were especially disappointing because there was an expected 0.4% increase in production. Financial analysts view these reports as further evidence of the need for forward guidance and possibly even quantitative easing, and the use of these economic catalysts will be determined in the Bank of England’s (BoE) meeting this August. However, this fall in production contrasts the recent rise in manufacturing PMIs, which were placed at 51.5 in May and 52.5 in June. Analysts suspect that bearish speculation caused by rising PMI levels may have been the reason why the pound sold off to such a degree.

The euro currency recently suffered a three-month low at $1.2760 against the dollar caused by misstatements from Joerg Asmussen, a member of the European Central Bank’s Governing Council. He stated that the central bank would continue to keep interest rates low for a period of time spanning over 12 months, a statement that was later contradicted by the ECB, which clarified that no length of time was ever actually determined and that Asmussen hadn’t intended to give one in the first place. ECB President Mario Draghi reported in a press conference that his plans for forward guidance would not be limited to a specific time frame.

With easy monetary policy maintained in Europe and the U.S., it is likely that the BoE will have to continue accommodative policy in this environment of competitive devaluation. Action in global currency markets and a recent string of weak data may force the BoE to consider more aggressive policies during their next meeting in August.

Should the BoE announce a policy of quantitative easing after their meeting in August we will see some serious downside in the pound. With British Pound Currency Futures trading near 1.51, we can calculate an expected move from now until September expiration. The at-the-money straddle is implying a move up or down of .044 by Sep expiry. This gives us a downside target of 1.466. Using this target we can set up an options strategy.

Trade: Buying the 6B Sep 1.48-1.47 Put Spread for 0.0025
Risk: $156.25
Reward: $468.75
Breakeven: 1.4775

This trade sets up for a great risk to reward ratio with a more conservative target than the straddle is implying.

Click to enlarge.

About the Author
James Ramelli

James Ramelli is the Moderator of the Live Futures Options Trading Room at KeeneOnTheMarket.com where he actively trades futures and options on futures while educating members on strategies, setups and risk management. He has a degree in Finance with a focus in Derivatives Trading and Financial Engineering from The University of Illinois and has been trading for five years. James appears regularly on Bloomberg T.V. and BNN and writes a weekly column for Futures Magazine.

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