Over the last few months, debt issues in Continental Europe have rocked the euro zone. Many nations are facing high budget deficits and yields on government debt in these countries is approaching double digits, leading many to think that default is right around the corner. Several nations and supranational organizations have stepped up to prevent this from happening, pledging hundreds of billions in aid to nations such as Greece in order to stop a contagion situation from happening throughout the euro zone. However, many are growing increasingly concerned over the situation in the UK as well. Inflation is running high and austerity measures have, so far, failed to help bring budget deficits back under control. As a result, Moody’s recently warned that the country’s AAA credit rating could soon be at risk, although the company still maintains a ‘stable’ outlook for now. “Although the weaker economic growth prospects in 2011 and 2012 do not directly cast doubt on the UK’s sovereign rating level, we believe that slower growth combined with weaker-than-expected fiscal consolidation efforts could cause the UK’s debt metrics to deteriorate to a point that would be inconsistent with a Aaa rating,” said Sarah Carlson, an analyst at Moody’s Investors Service.
Due to these concerns, today’s Bank of England meeting looks to be especially important, as it could signal how the central bank expects the British economy to fare in the rest of 2011 as well as the Bank’s plans for raising rates to curtain inflation in the medium-term. While pretty much all economists expect the BOE to keep rates steady at 0.5%, many will likely look for the Bank to signal rate increases later this year or early next. Inflation came in at 4.5% in April, a two-and-a-half year high, and well above the the 2.0% target that the central bank sets. However, growth has been pretty weak in the country as the national GDP has been flat over the past six months.
Food and energy inflation has been the biggest culprit for the price hikes across the country as staples have soared by 25% and the annual rate of price increases for all types of food hit 4.9% in May. These increases in food costs, compounded with rising utility rates across much of the nation, is hitting the beaten down British consumer especially hard making a rate increase likely to hit the market sooner rather than later, if for no other reason than to contain these potentially crippling developments. Nevertheless, with growth so abysmal, many are hoping that the Bank will hold out a little longer in hopes that continued easy money policies will help to stoke GDP growth later this year. ‘While increased utility prices and high inflation puts the MPC in an uncomfortable situation, countering this with a rise in interest rates would be a mistake. As long as wage increases remain subdued, the MPC should hold its nerve for the time being.’ said David Kern, chief economist at the British Chambers of Commerce (BCC).
Thanks to this important meeting, investors should look for the iShares MSCI United Kingdom Index Fund (NYSEARCA:EWU) to remain in focus throughout Thursday’s trading session. The fund tracks the MSCI United Kingdom Index which measures the performance of the British equity market. In total, the ETF holds 110 securities and has close to 20% in both the energy and the financial services sectors. Thanks to continued worries over debt crises in many of its neighboring markets as well as concerns over its own debt and inflation problems as well, EWU has has a rough start to 2011, gaining just 4.1% so far this year including a 3.1% drop in the past week alone. Should the BOE be able to soothe investor fears over a growing British debt crisis, EWU could surge in Thursday trading. If, however, rate hikes look to be put off indefinately and investors continue to worry over inflation, look for EWU to continue its recent downtrend and fall on the day.
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