Bank of England Rate Decision (11:00 GMT; 7:00 EST)
Expected: 5.50%
Previous: 5.50%

How Will The Markets React?

There have already been three interest rate decisions so far this week. The Reserve Bank of Australia didn’t surprise anybody last night when Governor Glenn Stevens announced the policy group was keeping the nation’s overnight cash rate unchanged at 6.25 percent. A little later in the day, the European Central Bank’s meeting concluded in the same lack of surprise for the markets, though the decision itself made a few more waves as the benchmark rate for the region was lifted 25 basis points to 4.00 percent. Finally, the Reserve Bank of New Zealand took that last step by overriding the consensus among economists and hiking its own OCR to a nine-year high 8.00 percent. With all this activity perking speculation and testing historically low levels of volatility, traders now turn a more watchful eye on the Bank of England’s own rate decision. Both the market and economists are expecting policy officials to leave rates untouched at 5.50 percent. This outlook is backed by a number of data highlights that suggest the Monetary Policy Committee will hold its hand in order to gauge whether past efforts to cool growth and inflation are taking effect. For growth, economic expansion cooled only slightly in the first quarter from a 3.0 percent pace to 2.9 percent, though this was enough to record the first deceleration in seven quarters. Perhaps more pressing though was the pull back in analysts’ preferred inflation gauges. The annual consumer price index for April fell back from its decade high 3.1 percent gait in April as the retail price index stepped back from its equally hot 4.8 percent pace. On the other hand, these levels are still well above the BoE’s tolerance band. What’s more, this is the first meeting since a 9-0 vote for a hike in May which followed a letter from Governor King to Chancellor Brown to address what is being done to rein in rampant price growth. So will this meeting turn out to be more like the RBA’s or RBNZ’s rate decision? Only time will tell; but speculation will happily fill the void until then.

Bonds – 10-Year Long Gilt

Yields on the benchmark ten-year gilt have steadily risen since the middle of March when data really started to fuel expectations of another round of monetary policy intervention. When yields first began to turn, data was fueling a steep rise as speculators attempted to divine the possibility that the notoriously unpredictable BoE would steer interest rates towards. Ironically, when a rate hike seemed almost certain, the rally cooled somewhat. Gilt traders were given the closest thing to a promise that a rate hike was in store when BoE Governor Brown wrote the first letter to the Chancellor of the Exchequer describing what would be done to bring inflation in line. Following trend, now that things are uncertain and rates expected to be held steady, yields are back on the rise.

FX – GBP/JPY

GBPJPY has done nothing but drive itself into an even tighter wedge formation as markets await the next big shift in rate differentials. Will the carry trade prevail or will traders liquidate their leveraged positions en masse? With central bank action on the docket this week, GBPJPY could maintain its lofty levels as price has steadied above support at 241.00. The Bank of England is widely expected to leave rates steady at 5.50 percent on Thursday morning, however, the British monetary policy makers have been known to surprisingly hike in the past, citing upside inflation risks. Following the Reserve Bank of New Zealand’s unexpected rate hike Wednesday evening, traders may be feeling especially edgy ahead of the UK central bank’s announcement. If the BOE defies analyst estimates, the British pound will surge, sending GBPJPY hurdling towards resistance at 243.00. However, should we see steady UK rates, GBPJPY may go little changed or soften slightly, as no statement will be released and markets will have to await the release of the meeting minutes on June 20th. Furthermore, if we see a combination of unchanged rates in the UK along with a sustained bout of Japanese yen strength, GBPJPY could break support, resulting in precipitous declines towards 239.00.

Equities – FTSE 100 Index

The UK's FTSE 100 Index followed other global equity indices, falling 1.7 percent - the most in more than two months - to 6,522.7 as all but two stocks in the benchmark retreated. The sole survivors included Rolls-Royce Group Plc and Royal Bank of Scotland Group Plc, while Marks & Spencer Plc led retailers lower and Rio Tinto Group paced a decline by mining companies. Marks & Spencer, the biggest UK clothing retailer, plunged 2.7 percent to 674 pence while Next Plc, the UK's third- largest clothing retailer, lost 3.2 percent to 2123 pence. A retreat in metals sent Rio Tinto, the world's third-largest mining company, down 3.4 percent to 3550 pence, as Anglo American slipped 4.1 percent to 2940 pence.

The FTSE 100 could be in for hard times on Thursday, as a rate decision by the Bank of England looms on the horizon. While the Bank is widely expected to leave rates steady at 5.50 percent, the British monetary policy makers have been known to surprisingly hike in the past, citing upside inflation risks. Such a result this time around could send the FTSE 100 spiraling lower towards 6,400 as interest rates become more restrictive for the economy as a whole. Furthermore, with the index already below a major supporting trendline, it will be even more vulnerable to declines. On the other hand, a decision to leave the overnight lending rate unchanged could leave UK equity traders breathing a sigh of relief and going back to their bullish stance.

Terri Belkas is a Currency Analyst for FXCM.