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Weak interest rates forecast until 2003 Back  
Austin Hughes, chief economist IIB Bank
A quite exceptional combination of factors is putting downward pressure on interest rates right along the yield curve at the moment. It is possible that their influence could intensify on a one to three month view, but beyond that I would expect to see a snapback with significant increases all the way from one-year money out.

At present the global interest rate climate is being shaped by (1) a gloomy outlook for economic activity and employment (2) a sharply improving inflation outlook that follows from the downturn in activity and is amplified by an emerging turnaround in oil and food prices (3) ‘Flight to quality’ movements into interest rates and out of equities (4) the strong current commitment of Central banks to underpin economic activity and financial stability and (5) the impact of fairly healthy trends in public finances for a number of years.

I think recent events both darken the immediate economic outlook and, as large interest rate cuts and looming budget support take effect, they also increase the prospect of a somewhat stronger eventual rebound. Furthermore, as financial markets come to expect budget policy will play an increasingly important role, upward pressure on the longer end of curves will intensify.

An increase of 225 basis points between November 1999 and October 2000 sets a precedent that may begin to unsettle markets. By the middle of next year the headline inflation rate for the Euro area will likely have troughed and, if this coincides with an improving outlook for activity, the ECB could be anxious to avoid being accommodative for any great length of time.

If this coincides with a significant upturn in US economic fortunes or a substantial deterioration in the budget position in the States or Europe there may be scope for quite a sharp rise in term interest rates. fear and market positioning could lead to a sharp initial uptick and what eventually proves to be a significant overshoot of the eventual path of ECB official rates. However, it may take some considerable time to prove that initial market pessimism is excessive. In the interim, it seems that three and five-year money could easily rise by 75 basis points or more by next summer and possibly quite a bit sooner.

It is usual for greed to cause borrowers to delay locking in to fixed rates and it is now time to at least begin consider this option. There may still be time as near term economic data should confirm another downleg to economic activity worldwide. Only the very nimble or those very pessimistic about longer term economic prospects should not give some thought to locking in the next month or two. The three-year area may offer significant comfort for the risk averse.

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