Although Greece passed austerity measures last week, the euro zone is not out of the woods on its debt crisis by a long shot. Further plans to help Greece could be viewed as a default by some ratings agencies and Portugal was recently downgraded to junk status, casting further doubt over peripheral members of the euro zone. Nevertheless, the ECB looks to raise rates later today at its policy meeting, suggesting that even with all the troubles, a move higher in rates is warranted in order to help keep quickly growing economies like Germany in check. Thanks to this likely move, the pressure looks to be on the central bank of England which also meets today, as many traders will likely look for the BOE to make a move closer to raising rates in order to curtail rising inflation concerns which are beginning to plague the British economy. Despite inflation that is above the BOE’s limit, the bank has been slow to raise rates unlike its counterpart in Frankfurt. In fact, at the most recent policy meeting for the BOE, members voted 7-2 to keep rates on hold, even though inflation rates are fast approaching 5% in the country. “In our view, the weakness in domestic confidence and demand together with indications of slowing global activity are likely to increase the pressure for more QE in the near term.” said Barclays Capital in a statement. “However, with inflation set to rise above 5% we doubt that a majority of MPC members would support such a move. At the same time, unless there is a marked turnaround in the demand outlook we think it unlikely that a majority will form around raising the policy rate. The outcome is likely to be a prolonged period of policy inertia.” [see all the currency ETFs here]
In fact, some analysts are even calling for the Bank to expand its QE program in the near future, increasing the level of asset purchases from their current level of 200 billion pounds. “The May Inflation Report forecasts were notably higher than at other times when they have done more QE,” Nick Bate, economist at Bank of America Merrill Lynch, said. While the Bank has made comments in the recent past that suggest that the BOE is open to more QE, analysts are only pricing in a one-in-four chance of this actually happening, and members of the Bank have taken steps in order to dispel a notion of further easing unless the economic situation significantly worsens. “It always starts with our medium-term assessment of inflation … if we saw that sinking down toward deflation territory is I think where asset purchases would come in.” said BOE Executive Director Markets Paul Fisher. “What would cause that to happen would be a sudden tip-over in growth now and that is a risk.”
Thanks to this key meeting and the increasingly divergent rates between Great Britain and its counterparts on the mainland, investors should look for the CurrencyShares British Pound Sterling Trust (FXB) to remain in focus throughout today’s trading session. The fund tracks the GBP/USD exchange rate, measuring the relative value of the British pound against the American dollar. So far in 2011, FXB has managed to gain a little under 2% against the greenback, a level that is far lower than many of its counterparts in Europe. In fact, the franc has gained over 10% against the dollar while the euro, despite all its troubles, is up more than 7% as well [see more fundamentals of FXB here].
A stronger commitment to tackling inflation is likely to help FXB in the days ahead while any prospect of further QE or higher inflation in the final quarters of the year could send FXB lower against the greenback in today’s session. In addition to this meeting, traders are also likely to look at the European Central Bank meeting as well; if the ECB fails to raise rates it could help to keep the pressure off of the UK for the time being. Yet, if the ECB continues to raise rates despite concerns over many of its members and their debt loads, the pressure could begin to mount for the BOE to do something, especially given the very real inflation concerns facing the country, potentially setting up FXB for some very rocky trading in the days ahead [ETF Insider: Tread Lightly In Uncertain Times].
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Disclosure: No positions at time of writing.