Interest rates dominate this week

The FOMC decision will be a key focus point this week. No-one is expecting any change in interest rates, but the markets will be closely watching the statement both on inflation and employment. The previous fed statement described new hiring as 'subdued', while Fed Chairman Greenspan last week characterised new job creation as 'lagging badly'. Any change to acknowledge the recent disappointing labour data would send a clear dovish signal to the markets. The other key part of the statement that could move markets is the bias towards inflation. January's statement came within a whisker of moving to a neutral bias, and this is likely to remain the case this time as well. The Fed has already managed to move away from the 'considerable period' phrase with regards to its maintenance of policy accommodation. So for now, there is little need for the Fed to move from the word 'patient' over the timing of removing policy accommodation.

Monetary and fiscal policy are in the spotlight in the UK this week. Chancellor Gordon Brown delivers his annual Budget on Wednesday. The Chancellor's forecasts for growth in 2004 and 2005, long derided as seriously over-optimistic, now look well within the bounds of possibility. His forecasts for borrowing look sound too, following the GBP10bn upward revision to borrowing forecasts in the 2003 Pre-Budget Report. The Chancellor as ever will announce a number of new but largely cosmetic measures for tax and spending. But with the election looming, any major changes to personal taxation look unlikely. Brown could however use his speech to give implicit support for the Bank of England to continue to raise interest rates.

The Bank would appreciate that support. It has a tough job on its hands, with house prices once again accelerating in early 2004. Opinion is divided as to the next rate rise, with some calling for a hike as soon as April. On Wednesday the minutes to the Bank of England Monetary Policy Committee (MPC) March meeting are released. The vote will prove key. With house prices proving far more resilient than expected, there is a good chance that one member - possibly two - voted to raise rates in March. Should that prove to be the case, talk of an April rate hike would be revived. Strong February retail sales data (we look for an above-consensus 0.3% m/m (6.2% y/y)) would add to that, while the 2%-odd depreciation in sterling since the March meeting - should it continue - would cement the view. It's all still to play for in terms of an April rate rise, but the situation will be much clearer by the end of this week.