Bank of England Rate Decision Promises Action No Matter The Outcome

Bank of England Rate Decision (11:00 GMT)
European Central Bank Rate Decision (11:00 GMT)
Expected: 5.50%
Expected: 3.75%
Previous: 5.25%
Previous: 3.75%

How Will The Markets React?

Each week, there is a key event that the entire FX community monitors for its possible effects on overall market volatility and behavior. Last week, US nonfarm payrolls stole the spot light from a particularly full global calendar. This week, the defining event will be the back to back announcement of the Bank of England and European Central Bank Rate decisions. These two meetings are typically market moving in nature, but they may be even more so this time around since the BoE is expected to lift its overnight cash rate while the ECB is predicted to make the subtle change in its statement that would signal a hike is on deck for the June meeting. Tackling the events chronologically, Governor Mervyn King is fully expected to lift the benchmark UK lending rate 25 basis points to 5.50 percent. This would certainly have a heavy impact on the local markets. Equities could certainly be deemed overbought after hitting new highs only a few days ago and gilt yields may finally catch up to the rampant rate speculation. On the other hand, the pound may be looking at some unusual price action since traders have worked to price in the quarter-point move over the past few weeks. Looking at the fringes of the probability pool, more than a few market participants are actually calling for a surprise 50 basis point hike - a move that could stamp out stubborn inflation that is running at its hottest pace in a decade. While this would be an aggressive move indeed, it is not beyond the BoE?s capabilities. If the benchmark lending rate is raised to 5.75 percent, it would likely stimulate considerable volatility and drive a wave of carry trade buying throughout the currency market. However, the BoE?s time in the spot light may also be contingent on the ECB?s moves. Should central bank president Jean-Claude Trichet revive “strong vigilance,” traders may be side tracked from the BoE follow through.
Bonds -10-Year Long Gilt Futures
Benchmark gilts have had trouble with support recently. For the active 10-year long-gilt futures contract, 106.40 has held up to a number of runs. Under normal circumstances a technical floor would not be unusual. However, this stalling is curious when economists are expecting the Bank of England to lift the overnight lending rate to 5.50 percent at the conclusion of its meeting. What?s more, with the potential for a 50 basis point hike finding considerable support, the risk seems even greater. The lack of follow through in yields may indicate the quarter-point hike has been priced in for some time. However, this would mean the masses were expecting it long before the surprise surge in inflation. Alternatively, the risk may be undervalued - in which case, a breakout move could be in the works.

Now that EUR/GBP has reached the terminal point of a large triangle formation and has also managed to slip below .6800, some of the pressure may have been relieved ahead of the European Central Bank and Bank of England policy decisions. Indeed, heavy resistance at .6800/35 and solid support at .6750 limits major moves for the pair, but given the event risk at hand, these levels may mean absolutely nothing. First we will take a look at the bullish British pound scenario: while a 25 basis point hike is likely priced into the currency, there is risk that the BoE will either signal another increase in June or will actually take the benchmark 50 basis points higher. If we see such an event, EURGBP could easily take out .6750 to target .6700. This kind of move would only be exacerbated if the ECB failed to signal policy tightening in June with the phrase “strong vigilance.” On the other hand, looking at the bearish British pound scenario: if the BoE only goes 25 basis points higher and ECB President Trichet indicates to the markets that they will take the benchmark higher next month, EURGBP may spike higher. Nevertheless, only time will tell as history has shown us that interest rate decisions and central bank commentary remain some of the biggest market movers.

Equities - FTSE 100 Index
Despite a gain in mining stocks, the FTSE 100 eased back 0.1 percent to 6,549.60 amidst an anticipated rate hike by the Bank of England tomorrow morning. Rio Tinto rallied 11 percent to 3660 pence, even though the world’s third-biggest mining company said it hasn’t received any takeover offer from larger rival BHP. Leading declines, J.D. Wetherspoon Plc lost 5.6 percent to 670 after the owner of about 660 town-center pubs said annual profit will likely miss estimates as the company spends money refurbishing pubs ahead of a smoking ban in England this summer.
The FTSE 100 range could be threatened on the Bank of England?s monetary policy decision, especially as there is some risk that the Bank will tighten 50 basis points rather than the typical 25 basis points. As a result, if the BoE only raises to 5.50 percent, UK equities could hold within its recent range. On the other hand, an unexpected increase to 5.75 percent could send the FTSE 100 index tumbling through support at the 6,515.00 level.