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Weak interest rates forecast until 2003 Back  
Dermot O’Brien, chief economist at NCB Stockbrokers
Prospects for interest rates in Europe, as elsewhere, in the next few months are subject to a deal of uncertainty related to the extent to which the terrorist attacks on the US damaged the US and world economy. There are considerable uncertainties too associated with the potential repercussions from the retaliatory action on which the US is about to embark. That said, it is clear that monetary authorities are prepared to err on the side of avoiding downside risks to economies and the likelihood of further cuts in short-term interest rates in the US and Europe is high. In these circumstances, borrowers should stick with variable rates for the moment, especially until the economic and political picture becomes clearer. As short rates fall, interest rates in the 2-year to 5-year range should respond, though to a lesser extent. Nevertheless, it should still be possible to fix rates at levels somewhat lower than currently prevail.

Even if the impact on the world economy of the attack on the US is relatively short-lived, the likelihood is that the recovery in the US and European economies next year will be mild rather than rapid. As a result, it is likely that interest rates will remain low for a protracted period.

Longer-term, the economic and interest rate cycles will reassert themselves. Short-term rates will move higher, towards a neutral level, as the need for monetary stimulus subsides. The size of the potential upswing in rates in this context should be relatively limited, however. Given the ECB’s inflation target and a Eurozone economy whose growth potential is probably not much above 2.5 per cent, short rates in or around 5 per cent would represent neutrality and it is unlikely that, even in a monetary tightening cycle short rates would go much above 6 per cent or 6.5 per cent. Generally speaking, interest rates in the 2-year to 5-year range could be expected to rise by broadly the same amount as short-term rates in such circumstances.

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