While much of the focus in the markets will be on this evenings FOMC decision, those in the UK and even Europe have other things to worry about first as the minutes from the Bank of England meeting are released followed by the annual budget release from Chancellor George Osborne.
In recent years, the annual budget hasn’t really been viewed as much of an event for the financial markets as the changes announced are often leaked beforehand and make little real difference to the economy. With the government having its sight set on deficit reduction and fiscal responsibility, there’s little they can do to provide the kind of stimulus that the economy could really benefit from.
This budget is a little different as it comes only weeks before the general election – the tightest we’ve seen in years – the outcome of which could have profound implications for both the UK and Europe. A Conservative win would bring with it the uncertainties of a referendum on EU membership in the next couple of years, something UK exporters will be quite worried about.
Another threat to the UK economy in the next 12 months could be rising interest rates, with the Bank of England considering raising them from their record lows potentially as early as the end of this year. While the UK economic recovery has been quite strong, it remains very fragile and even a small rate hike could derail it. The BoE is well aware of this and is likely to tread carefully when it does start hiking rates.
The minutes from this month’s meeting could show two of the more hawkish members of the Monetary Policy Committee – Martin Weale and Ian McCafferty – voting in favour of a rate hike which technically would increase the odds of it coming this year. Both were voting in favour of a hike for the majority of the second half of last year but the significant decline in inflation prompted them to rethink their position.
While inflation still remains low, the minutes are likely to show that members don’t view it as a threat at this stage as it is primarily being driven by declining oil and food prices. Aside from being two of the more volatile components of the inflation reading, deflation in these is actually seen as a positive for the economy as they are compulsory spends which leaves consumers with extra money in their pockets. In a consumer driven economy like the UK, this must be a good thing.
It’s this logic, along with expectations that inflation will return to the 2% target in the forecasting period, that could prompt Weale and McCafferty to vote for a hike once again. If they do, we could see a little support for the pound and yields on UK debt, but I think many almost expect that to come and therefore the shock factor will be minimal. That would come if any other members voted in favour as it would show an actual shift in the voting that could suggest an earlier rate hike than even the more hawkish among us expect.
Later on this evening we’ll get the latest monetary policy decision from the Federal Reserve, along with the usual statement, new economic projections and dot plot showing each members forecast for interest rates. This event could create big waves in the markets as the first Fed rate hike is seen as one of the biggest threats to the markets at the moment. Despite the fact that it signals a dramatic improvement in the economy, people are genuinely worried about what impact it could have on the markets after years of monetary easing and high asset prices.
The key thing at this meeting is whether the Fed maintains its commitment to be “patient” on interest rates or removes it from the text. Chair Janet Yellen stated previously that it meant the Fed would not move on rates for at least a couple of months. In effect, the removal of the word would effectively signal an imminent rate hike, potentially as early as June. If that happens, I think investors will panic as it would signal the beginning of the end of this low yield environment, in the US at least.
The FTSE is expected to open 8 points higher, the CAC 7 points higher and the DAX 36 points higher.
For a look at all of today’s economic events, check out our economic calendar.
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