The biggest event risk for the UK markets this week comes from the release of the minutes from the Bank of England’s March meeting, as they are likely to echo much of the same wary sentiment reflected in the monetary policy statement that was released in February. Indeed, the statement noted that “financial markets had continued to be stressed...The news on the month had indicated that pressure on banks’ balance sheets had continued to intensify...International equity markets, which had previously been affected less by the developments in credit markets, had fallen sharply in the middle of the month and had remained volatile since.”

March 19 Bank of England Meeting Minutes (9:30 GMT; 5:30 EST)
Expected: 8-1 In Favor of No Cut
Previous: 8-1 In Favor of 25bp Cut

What Are The Markets Facing?

The biggest event risk for the UK markets this week comes from the release of the minutes from the Bank of England’s March meeting, as they are likely to echo much of the same wary sentiment reflected in the monetary policy statement that was released in February. Indeed, the statement noted that “financial markets had continued to be stressed...The news on the month had indicated that pressure on banks’ balance sheets had continued to intensify...International equity markets, which had previously been affected less by the developments in credit markets, had fallen sharply in the middle of the month and had remained volatile since.” BOE Monetary Policy Committee member David Blanchflower was so concerned about these issues that he dissented in favor of a dramatic 50bp cut in February. On the other hand, the rest of the BOE MPC became more focused on building price pressures, as they said that “the Committee expected that higher energy and food prices would raise inflation, possibly quite sharply, in the coming months...There was a risk that above-target CPI inflation in the near term would affect inflation expectations, and hence have some tendency to persist in the medium term.” Furthermore, Bank of England Deputy Governor John Gieve said just a few days ago that, “As our minutes will show, we are monitoring inflation expectations extremely closely. Keeping inflation expectations anchored is absolutely key.” Nevertheless, it will be important to watch not only where the BOE’s concerns lie, but also the vote count. The March rate decision likely had at least one vote from über-dove Blanchflower for a rate reduction, but the more votes in favor of a more accommodative monetary policy, the more the markets will price in an April rate cut.

Bonds – Long Gilt Futures

Gilts have remained within a rising channel as liquidity concerns have sent the smart money into its safe havens. The contract ran into resistance at 112.00 and fell to trend line support, when the recent Bear Stearns collapse reignited fears that a systematic US banking failure would reverberate throughout global markets. Nevertheless, if the minutes of the BOE’s most recent policy meeting reflect a dovish bias, Gilts could hold above support to target 112 once again. On the other hand, a pronounced focus on inflation will likely weigh the contract down towards 111.

FX – GBP/USD

The GBP/USD recently rallied off of significant support at 1.9960 yesterday, and this level has served as a long-term support/resistance for the pair for the past six months. Meanwhile, the 20-day SMA, which has been a source of short term support, reinforced the level and sent the pound shooting towards resistance at 2.0400. The cable’s momentum was buoyed by a 2.5% CPI print, the highest reading in nine months, which gave support to the BoE’s contention that inflation will break their 3% threshold. A breach of this level is significant because it requires Governor Mervyn King to write a letter of explanation to government officials. Therefore, the MPC will try and avoid this at all costs, which diminishes the possibility of any rate cuts until inflation starts to ease. On the other hand, business leaders have called for further rate reductions to help Britain’s deteriorating housing industry, which has seen prices continue to fall, while the global credit crunch and recent failures of the Carlyle Group and Bear Stearns demonstrates the need for proper liquidity in the market and may become an overriding factor in the BoE’s decision making process.

The upcoming minutes from their last policy meeting and subsequent comments will give the markets insight into where their priorities lie and what weights they are allocating toward each factor. Therefore, if the central bank reiterates their hawkish tone, it may send the pair to test resistance continuing its current momentum. However, any hint that the MPC is turning its eye towards the liquidity issues that have wreaked havoc in the U.S., may see Cable fall through the long-term support level.

Equities – FTSE 100 Index

Expectations for the FTSE 100 are to the upside after hitting its worst levels since late 2005, and subsequently surging higher amidst a global return to risk. On Wednesday, traders will see the Bank of England’s minutes from its March Monetary Policy Committee meeting. Recent instability in the banking sector has taken a toll on equities at a time when central bankers are scrambling to come to the rescue. Any indication of a bias towards future interest rate easing by the BOE could give an additional boost to the FTSE 100, though the gains may be short-lived as the equity markets remain overwhelmingly bearish.

Terri Belkas is a Currency Strategist at FXCM.