Previewing the Central Bank Action Next Week

European leaders have agreed on new crisis fighting measures at the ongoing summit in Brussels, but next week markets may turn their focus back to monetary authorities. After the fiscal authorities agreed to step up crisis fighting measures, investors will next see if central banks in Europe will match the fiscal stimulus.

The Bank of England (BoE) and the European Central Bank (ECB) each meet on Thursday, July 5, and markets might be expecting action from each. Economists polled by Bloomberg expect the BoE to keep interest rates flat at 0.5 percent. However, economists also predict that the bank will increase the size of its quantitative easing program by $78 billion to $585.25 billion total, a 13 percent increase. Increasing the size of this program might be bearish for the pound, especially against the dollar (GBP/USD), and may boost British financial stocks, including Barclays BCS and HSBC HBC.

Also on July 5, the ECB is set to announce its interest rate decision. Friday, economists were expecting a rate cut of 25 basis points from 1.0 percent to 0.75 percent. Money markets have potentially been pricing this cut for several weeks, and Friday's economist expectations affirmed this money market outcome. Also, markets may be looking for comments from ECB President Mario Draghi after the European leaders agreed to create a banking regulator within the ECB. Within these comments, markets may be looking for any indications of further non-traditional policy measures. Investors might recall that Draghi first announced the Longer Term Refinancing Operations (LTRO's) at a similar press conference.

The pricing in of a rate cut by money markets may signal that, to generate a large market response, the ECB would have to take further action. Generally, it is assumed that expected news is not market moving, and therefore solely cutting rates may not be enough to create a significant market reaction. If the ECB hints at any further easing policies though, markets could respond more significantly. New rounds of cheap financing, such as more LTRO's, could cause a rally in banks as borrowing costs would be lower than market rates on these loans. The ECB has been reluctant to launch unsterilized quantitative easing, unlike the BoE and the Fed, and thus such a policy announcement might surprise markets. The EUR/USD would likely sell-off, as the ratio of balance sheet size between the Fed and the ECB is correlated to the price movement of this exchange rate.

U.S. traders waking up from the July 4th holiday will have a lot to analyze on the fifth, when these announcements are due out by 7:45 am est. Traders may want to position accordingly at the close on Tuesday, July 3rd, as markets are closed on the holiday.