LONDON -- The U.S. Federal Reserve meets this week to set interest rates but it's the central bank's accompanying statement rather than the decision itself that will have the greater impact on financial markets.
The Fed is widely expected to leave borrowing costs on hold at 5.25 percent, meaning investors will scrutinize every word of the statement for clues on the outlook for monetary policy.
U.S. housing sales data will be closely watched for signs that weakness in the riskier subprime sector, which has fuelled uncertainty in credit markets and the hedge fund community, has spread to the broader housing market.
Later in the week, the latest reading of the Fed's preferred measure of inflation, the core personal consumption expenditures index, is expected to show only very modest price pressures.
Story Continues Below
The Norwegian central bank, meanwhile, is expected on Wednesday to become the latest European monetary authority to raise rates in June, following in the footsteps of the European Central Bank, Swiss National Bank and Swedish Riksbank.
With many of the major central banks around the world in tightening mode, bond yields have backed up to multi-year highs in recent weeks, sending jitters through financial markets.
The Fed's statement on Thursday could prompt renewed swings in bond yields.
"The risk that inflation fails to moderate probably remains the predominant policy concern, although there is some chance the exact language is tweaked since year-on-year core CPI has slowed to 2.2 percent from 2.7 percent in February," HSBC economists said in a note to clients.
"The statement could acknowledge that economic growth appears to have regained some momentum after slowing in the first part of the year. The adjustment in the housing sector could remain 'ongoing'.
Meanwhile, the statement could also recognize that recent core inflation readings have improved but should continue to highlight resource utilization pressures."
If U.S. rates are left at 5.25 percent it will be almost exactly a year to the day since the Fed last changed them.
Expectations of Fed rate cuts have all but evaporated. In December financial markets discounted 75 basis points of easing in 2007. Now, they show the Fed staying on hold for the rest of the year.
Data next week showing the latest core PCE figures and a likely decline in new and existing home sales in May could shift those expectations.
Global bond yields have moved sharply higher this month, fuelling the currency carry trade that has seen low-yielding units like the yen and Swiss franc slide to new lows against many higher-yielding counterparts.
In this context, comments from central bankers gathered this weekend in Basel, Switzerland for the Bank for International Settlements' annual meeting, could be important for markets.
But U.S. yields have eased back in recent sessions as concerns about the housing market and potential overspill into credit markets have resurfaced.
"The housing market remains a risk for the U.S. economy, and there is likely more bad news to come from the subprime mortgage market," Morgan Stanley wrote in a weekly note.
"While the outlook for the real economy remains on a solid footing, there is some rising concern about the potential for financial market dislocations."
In Europe, however, the path for growth, price pressures, interest rates and yields appears to be more fixed: upward.
Norway's central bank is expected to raise rates a quarter percentage point to 4.5 percent, while investors will continue to digest the hawkish rhetoric that's been emanating from the ECB, SNB, Riksbank and Bank of England lately.
In the euro zone, German June unemployment data, euro zone May money supply figures and flash estimates for June euro zone inflation are the data highlights.
Annual inflation is expected to come in at 1.9 percent, unchanged from the previous month and in line with the ECB's target of below but close to 2 percent.
But ECB policymakers and financial markets are unlikely to get complacent.
"Even allowing for faster-than-average capacity growth and a moderate slowdown in demand growth, CPI inflation is more likely to be slightly higher than 2 percent than below it in 2008," economists at Goldman Sachs said.
"Unless activity slows meaningfully, we doubt the ECB would want ...to stop raising interest rates."
© Reuters 2007. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters.
Editor's note:
Big Gains as Stocks Go Up ... Or Down! -- Find Out How
Bernanke Reveals `Fiscal Crisis` Ahead
12 Ways to Recession Proof Your Portfolio
