What Are The Markets Facing?

On Wednesday, the 4:30 EDT release of the minutes from the Bank of England’s June meeting – when they left rates unchanged at 5.00 percent – presents major event risk for the markets as they are likely to reflect much of the same hawkish sentiment seen in the meeting minutes from May. Indeed, the minutes showed tha`t in May, for most members a rate cut would “make it more difficult to keep inflation expectations in line with the target,” and while “economic activity was likely to slow…some slowing in the growth rate of output was likely to be necessary for inflation to settle close to the target around two years ahead.” Furthermore, the MPC cited concerns that the public would get the impression that a rate cut was an effort to “stabilize output growth rather than maintaining its focus on the inflation target.” On the other hand, the minutes are also likely to show one vote for a rate cut by über-dove David Blanchflower, who said last month that the “factors pushing inflation up…were beyond the MPC’s control and…current and prospective weakness of demand meant that there was a clear risk of missing the target on the downside looking further ahead.” However, if the vote count actually shows that the decision to leave rates steady was a unanimous vote, or if there were any votes for a rate increase, the UK markets could price in a higher Bank Rate as they shrug off BOE Governor King’s suggestions in his letter to Chancellor of the Exchequer Alistair Darling that the MPC will leave rates steady in the hopes that an economic slowdown will quell rising price pressures.

Bonds – Long Gilt Futures

Long Gilt futures have bounced from support at 103.60, but the upcoming release of the BOE’s meeting minutes from June could lead the contract to give up Tuesday’s gains. Indeed, if the minutes surprisingly show a unanimous vote for unchanged rates or one or more votes for a rate hike, Gilts could fall back toward 103.60, which sharp declines taking the contract to the July 2007 low of 102.90. On the other hand, one or more votes for a rate cut in June could be enough to lead Gilts higher to target resistance at 105.40.

FX – GBP/USD

GBP/USD continues to consolidate within a wide range of 1.9400 – 1.9800, as the British pound tumbled on. At first glance, the drop in the British pound was somewhat surprising as the annual rate of UK CPI growth rocketed to a nearly 16-year high of 3.3 percent, prompting Bank of England Governor Mervyn King to write a letter to Chancellor of the Exchequer Alistair Darling explaining how inflation had gotten so out of control, and how the Bank plans on bringing CPI back down to the 2.0 percent target. However, it was the very letter that Mr. King penned that hammered the British pound lower, as he indicated that the Bank of England’s attempts to quell inflation growth would be over the course of two years, rather than one. Furthermore, Mr. King’s comments killed any hopes in the markets that rate hikes by the Bank of England were a sure thing. Indeed, the Bank of England has a dual mandate to maintain both price stability and economic growth. With the UK economy already slowing markedly, the Bank is worried that rate increases will push the country into recession. As a result, they are likely to leave rates steady throughout the year, as the Bank hopes that the UK economic slowdown will help to drive down domestic price growth.

Nevertheless, the release of the BOE meeting minutes from June could shift these expectations, if even for only a short time. If the vote count shows a unanimous vote for unchanged rates, or one or more votes for a rate hike, GBP/USD could surge toward 1.9700. Additional resistance looms above at 1.9750/65, where we have the confluence of a falling trendline and the 100 SMA. On the other hand, one or more votes for a rate cut could send GBP/USD tumbling toward 1.9500 or lower.

Equities – FTSE 100 Index

The FTSE 100 surged on Tuesday but ran headlong into 100 SMA and trendline resistance at 5,900/33 as BOE Governor King’s letter to Chancellor of the Exchequer Alistair Darling effectively put an end to speculation that the central bank would raise rates anytime soon. However, the FTSE 100 could give up its gains as the minutes from the BOE’s meeting in June will be released, and the news could shift those expectations once again, if even for only a short time. If the vote count shows a unanimous vote for unchanged rates, or one or more votes for a rate hike, the FTSE 100 could tumble below 5,800 toward support at 5,720. On the other hand, one or more votes for a rate cut could send the index jumping through near-term resistance at 5,900/33 toward 6,000.

Terri Belkas is a Currency Strategist at FXCM.