Wednesday's ETF to Watch: United Kingdom ETF (EWU)

Over the last week, equity markets have fallen back as investors have grown increasingly worried about the high levels of unemployment and budget deficits that are plaguing a variety of developed markets around the world. This is especially true in Great Britain, which is facing a deficit of over 12%, unemployment just under 8%, and anemic levels of growth going forward. This dismal economic situation has put the Bank of England into focus as the central bank attempts to revive growth without stoking the fires of inflation. 

Today the country's economy will go under the microscope once again as the Bank of England gives its inflation report and figures from the government on the country's unemployment levels are also released. These two numbers could help to show which way the British economy is trending but unfortunately many analysts are expecting poor reports on both fronts as the British economy continues to weaken. "The U.K. data continues to disappoint and is putting sterling under renewed downward pressure," analysts led by Hans-Guenter Redekerin London, wrote in a research note today. "[The] inflation report should confirm the grim outlook on the U.K. We expect the BOE to cut its growth and inflation forecasts."

Should inflationary pressures continue to mount it could force the bank to raise rates from their historically low levels of 0.5% in order to contain inflation, which is now trending above 3% and is likely to stay there until 2012, according to some analysts. "Any fall in CPI inflation during the rest of this year is likely to be temporary, and our expectation is that inflation will remain well above target until 2012," said Simon Hayes, economist at Barclays Capital. "The projected persistence of above-target inflation will heighten concerns about inflation expectations, which have already risen on some measures." [also see Non-Euro Europe ETF Options]

However, it could end up being far more complicated than that should the government report that unemployment rates rose in the previous month. Given the central bank governor's ineptitude at correctly predicting the economic situation over the past few years, many would be extremely displeased with the Bank of England if it were to raise rates in a time of increasing unemployment. This dilemma puts the Bank in a difficult situation if both numbers turn out worse later today, leaving the policy makers with few options going forward and increasingly unsavory outcomes for either route they end up taking [also read Will "Decades" Of Austerity Crush British ETF?].

Because of these important reports, which could help to signal future actions by the bank, the iShares MSCI United Kingdom Index Fund (NYSE: EWU  ) should be in focus during Wednesday trading. The fund tracks the MSCI United Kingdom Index, a benchmark that measures the performance of the British equity market. In terms of sector exposure, the fund has heavy allocations towards financials (21.4%), energy (17.3%), and industrial materials (15%) while maintaining minimal allocations to the technology sectors, which combine to make up less than 1% of the fund's total assets [see more fundamentals of EWU here].

The fund is also overweight in large companies, with giant-caps making up slightly more than two-thirds of the total assets, and large-caps taking up another 18.9%. Its top individual holdings include banking giant HSBC Holdings (NYSE: HBC  ) (8.6%), Vodafone Group (Nasdaq: VOD  ) (5.9%), and Royal Dutch Shell (NYSE: RDS-A  ) (NYSE: RDS-AB  ) (4.8%). The fund charges an expense ratio of 0.52%, and like many European ETFs, this fund has sunk so far in 2010 posting a loss of 1.4%. However, the fund has surged higher over the past month, gaining over 10.2% and will put this sharp gain to the test after today's critical data reports give further insight into the British economy [see all the ETFs that offer exposure to Great Britain by using our new Country Exposure Tool].

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