Noel Griffin, Head of Treasury & Investments, Bank of Scotland (Ireland).
I believe all three markets will see rising interest rates over the period in question.
While I see euro interest rates remaining steady for the rest of this year I believe they will rise throughout 2005 and finish the year at 3.00%.
US rates will also rise but at a faster pace. Indeed I believe US rates will be substantially higher by the end of 2005 as confidence returns. Higher rates are inevitable given the current exceptionally low interest rate environment.
In the UK while interest rates will also rise the level of increase will be more modest. However, UK interest rates are starting from a much higher base and remain higher than both the euro and the US.
With economies improving interest rates will be raised to prevent a rapid rise in inflation. Hence we will see significantly higher US rates to avoid the inflationary threat brought about by increasing demand coupled with a weak currency.
As always I believe borrowers should not gamble on whether rates will remain low or speculate how long they will remain at current levels. The cost of borrowing is just one variable, which must be considered, and I would recommend a blend of variable and fixed rates to be part of any borrowing strategy.
Eugene Kiernan, Head of Asset Allocation, Irish Life Investment Managers
For the past few years, our interest rate mantra has been ‘lower for longer’. Its time to move on. However, we look for a kinder, gentler interest rate environment than perhaps the bears would think.
It is right that Central Banks at this stage of the cycle sshould take away some of the emergency liquidity which has been necessary to heal the Global economy. However there are no looming economic bubbles that require dramatic hikes in policy. The Bank of England has moved soonest to pre-empt possible stress arising from consumer debt levels. Global growth has certainly recovered but we are not, we believe, embarking on a multi-year phase of super normal economic growth. There are still sufficient imbalances in the world picture to suggest that a steady hand will be kept on the monetary tiller.
Given this gentle economic background, inflation would have to surprise dramatically of its own accord to upset policy makers. Inflation has been a bit of a ‘Roy Keane’ factor, in that for that the past two years it didn’t have to be considered; now it features in the equation again. Admittedly energy and other commodity prices are above the comfort level but there is sufficient excess productive capacity in the world’s major economies to offset these pressures. Our view is that over the forecast period, the global inflation rate will have a two to the left of the decimal point.
So reasonable economic growth with comfortable inflation prospects will drive rates higher but not by that much.
Oliver Mangan, Chief Bond Economist, AIB Global Treasury
The US economy and employment are likely to continue growing robustly, against a backdrop where inflation is turning upwards. Thus, we would not be surprised if the Fed moves to a tightening bias by midyear, paving the way for rate hikes to begin in Q3 2004.
We expect that the Fed will start hiking rates at the August FOMC meeting. By end 2004, we forecast that the Fed funds rate will have risen to 2.25 per cent. Further tightening can be expected in 2005, given that monetary policy will still be quite accommodatory at end 2004.
UK monetary policy remains quite accommodatory with the repo rate still well below the rate of nominal GDP growth of 5.5 per cent. Given the continuing strength of domestic demand and the further sharp rises in house prices and consumer borrowings, we expect that UK rates will be raised to 4.75 per cent by end 2004.
There have been conflicting signals coming from the ECB about the need for a further easing of monetary policy. This may be due to divided views on the ECB council over the matter.With the HICP rate expected to pick up again to 2 per cent in the next couple of months, the global upswing gaining momentum and the euro losing ground, the window of opportunity for a rate cut is closing. Hence, while a rate cut cannot be ruled out, our forecast is for unchanged ECB rates in 2004.
We do not envisage any tightening of ECB policy until well into 2005, given the sluggishness of the economic recovery to date. With an increase in ECB rates a long way off, borrowers in euros should not pay a significant premium for fixed rate loans.
Dan McLoughlin, Chief Economist, Bank of Ireland
The global economic recovery is now well established, led by the US, the UK and Asia, with the euro area lagging. Growth in the states has been particularly robust since the summer of 2003 and under normal circumstances would have prompted the Fed to tighten policy. Rates have stayed at 1 per cent however, because inflation is very low and employment growth had not picked up in line with previous cycles, allowing the Fed to remain ‘patient’ before commencing the tightening cycle. This patience may now be tested following the recent pick up in employment and evidence that inflation has bottomed. Market sentiment has certainly shifted, with swap rates moving sharply higher, although the case for fixing at 3 years and beyond is still worth considering as the risks now lie on the upside in terms of inflation and Fed policy.
The case for fixing is more compelling in the euro area, because the market is still giving some credence to the view that the next move in ECB rates is downward. I doubt this and suspect that 3-year swap rates of 2.80 per cent represent good value as business spending in the euro area is gaining momentum. Finally the UK market is pricing in a repo rate of 5 per cent over the coming year, which appears reasonable and as such the case for fixing is not that strong.
Alan McQuaid, Chief Economist, Bloxham Stockbrokers
The global monetary policy backdrop will remain supportive in the near-term, underpinning a pro-growth investment stance. The Federal Reserve will continue to lag the cycle to ensure that real interest rates stay low and economic growth remains solid. A flurry of Fed speeches in recent weeks indicates that the US central bank will be slow to hike rates.
Even if job growth remains strong in the months ahead, the Fed could still put off its first rate increase until early next year if core inflation remains quiescent.
However, with some Fed members keen to take a pre-emptive approach to higher inflation, a pick-up in core inflation, albeit gradual, should in my view see the Fed beginning its tightening cycle in 2004 rather than 2005. Overall, I am looking for a 50bps hike in rates to 1.50 per cent before year-end, with a further 50bps tightening in the first half of 2004. Indeed, the Fed’s Robert Parry has already suggested that the US central bank will at some stage have to bring the fed funds rate back to a ‘neutral’ level of around 3.5 per cent.
There was speculation that the ECB would cut rates at its April policy meeting, but I expect it to move by mid-year unless the euro slips sharply against the dollar in the interim. Political pressure on the ECB is building in light of clear evidence that the region’s recovery is stalling. Business and consumer confidence has already weakened ahead of the train bombing in Spain, and there is a risk of further deterioration without policy support. In contrast, the Bank of England despite leaving rates on hold at its April policy meeting continues to signal that it will tighten again in the near-term and is intent on slowing the booming housing and consumer sectors. However, with inflation below target and sterling strong, the Bank of England will move gradually rather than aggressively.
While the Bank of England is out front of the monetary policy cycle and the ECB is at the rear, the general trend in global interest rates is up in the coming 12-18 months. How quickly rates will rise is a function of inflation expectations. But with real interest rates at zero and inflation in the process of bottoming, there is substantial upside risks for rates once monetary re-normalisation becomes more widespread.
As regards the yield curve, I expect rates to rise further at the short-end rather than the long-end in the coming months, resulting in a flattening of the yield curve, but that said, most bond markets are over-valued in my view and 10-year yields will rise sharply going forward.
However, I think German bunds will significantly out-perform Treasuries over the remainder of 2004, and I think benchmark Euroland 10-year yields will end 2004 40 or 50bps below their US counterparts at 4.50 per cent or just under. Re-normalisation of official interest rates should see Eurozone 10-year yields back close on 5.00 per cent in the first half of 2005. As regards, fixed or variable rates, and my view of bond markets going forward, I have to say that I would be sticking to variable for the time being, because the Eurozone economy needs lower rather than higher official interest rates at this stage, and even on the assumption of an economic recovery in the region, it is hard to see the ECB aggressively raising official rates over the next 12-18 months.
Brendan Seaver, Country Treasurer, Bank of America
Three criteria are needed for the US Federal Reserve to start tightening monetary policy: (1) strong sustained economic growth, (2) sustained pickup in employment gains, and (3) modest rise in inflation. Recent data all point in this direction, but further evidence is needed to give the Fed enough confidence to start the tightening cycle. We expect the first hike in late summer, although the Fed’s language will likely start changing incrementally over the next few weeks. In the Eurozone, weak domestic demand and the continuing reliance on an external stimulus make the economy highly vulnerable to any loss in global growth momentum. The ECB will probably respond to the perceived downside risks to economic activity (and therefore to inflation) by cutting rates again by 50bps to 1.5 per cent by the summer. In the UK, the economy continues to power ahead. Resurgent house price inflation has boosted private consumption in late 2003 and early 2004. However, mounting economic imbalances in the UK remain a worry for economic growth at a later stage. The BoE is expected to raise interest rates only modestly further in the next few months, probably in two steps of 25bps each to 4.5 per cent. Global long-term yields are likely to rise over the coming quarters due to better economic performance, diminishing central bank buying of Treasuries and convexity hedging requirements. Investors should underweight duration.
The Fed is likely to remain behind the curve, suggesting bear steepening of the yield curve and lower borrowing costs for variable rate financing. The gap between US and Eurozone rates is likely to widen. |
