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Wednesday, 17th April 2024
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Weak interest rates forecast until 2003 Back  
Dominick Sutton, director, chief economist of Investec Ireland
The main economies and financial markets are currently occluded by high levels of uncertainty not only about the impact of the recent attacks on the US at a time of economic weakness in the global economy. They are also struggling to price in future interest rate trends when the scope and nature of the reply to those attacks - and any secondary attacks so engendered - are still almost wholly unknown. Whatever the nature of the military response it is clear that a revival in the US - and so global - economy is also part of the current response strategy.

This economic policy response will be concentrated in the two classical areas. US fiscal policy is already gearing up for a massive spending spree not only to prosecute the war but also to help business and consumers regain their equilibrium. The sums being spent in these two areas are vast - many hundreds of billions in aggregate and will, in time, likely produce a strong demand-led US economic recovery. Similarly, monetary policy is geared to assist economic recovery. US official interest rates have already fallen from 6.5 per cent to 3.0 per cent this year and are likely to fall to close to 2 per cent by the year-end. Gradual dollar depreciation is also likely to help ease monetary conditions further. Barring a further dramatic shock to the international economic infrastructure - something that remains unforeseeable for the immediate future, alas - the resulting US economic upswing could well prove to be strong and, potentially, inflationary. This explains the steepening of the US yield curve; despite 2 year bonds falling to record lows the curve beyond 5 years has sold off for fear of higher future inflation as a result of the steps to revive the US economy.

Developments in the US are undoubtedly finding an echo in the Euro Zone economy and policy formulation. The Eonia yield curve is already pricing in an interest rate decline to some 3.30 per cent during the next six months. However, the implied 1-year swap rate, for instance, backs up steadily from the current 3.5 per cent spot rate to over 6 per cent during the following years. It strongly suggests that Euro interest rates will be forced lower over the coming months as the full impact of the global recession bites in Europe but that an inevitable revival in activity - that may be accompanied by inflationary pressures - will see interest rates rebound within twelve months.

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