home
login
contact
about
Finance Dublin
Finance Jobs
 
Tuesday, 23rd April 2024
    Home             Archive             Publications             Our Services             Finance Jobs             Events             Surveys & Awards             
Interest rates are set to rise to 3 per cent in the Eurozone by Q1 2007 as ECB aims to ‘normalise’ rates Back  
Ireland’s leading financial services economists almost unanimously predict that interest rates in the Eurozone will rise an additional 75 basis points by the first quarter of 2007. However, there is not such a clear agreement with respect to US and UK rates, as although the economists agree that US rates will continue to rise, there is no consensus on the degree of the rise, and in the UK, some believe rates will continue to rise, while others predict a fall.
The European Central Bank (ECB) began its interest rate normalisation process earlier this month, when it announced its first rate cut since October 2000, moving the ECB’s refinancing rate up from a historic low of 2.00.

Speaking at the announcement of the rate hike on December 1st , ECB president, Jean Claude Trichet said, ‘Our decision to increase interest rates was warranted so as to adjust our accommodative monetary policy stance, while taking into account the risks to price stability that we have identified in our economic analysis, cross-checked by our monetary analysis. Our decision will contribute to keeping medium to long-term inflation expectations in the euro area solidly anchored at levels consistent with price stability. Such anchoring of inflation expectations is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth in the euro area. In fact, interest rates across the entire maturity spectrum continue to remain very low in both nominal and real terms. Thus, our policy remains accommodative and continues to lend considerable support to sustainable economic activity and job creation. We will continue to monitor closely all developments with respect to risks to price stability.

Although, speaking at this meeting Trichet confirmed that the bank would not ‘engage in a series of interest rate increases’, the economists responding to this survey are not so sure. According to Oliver Mangan, chief bond economist with AIB Global Treasury, ‘The ECB lo oks to have embarked on a rate hiking campaign, even if it says further policy tightening is not preordained’.

As such, there is a broad consensus amongst the economists that this is not the only rate increase we will see over the coming year, with economists predicting rates will rise to at least 3.00 by the end of the first quarter of 2005.

Contributors to the survey are: Niall Dunne, treasury economist, Ulster Bank, Austin Hughes, Chief Economist, IIB Bank, Oliver Mangan, Chief Bond Economist, AIB Global Treasury, Alan McQuaid, Chief Economist, Bloxham Stockbrokers, Dermot O’Brien, Chief Economist, NCB Stockbrokers, Noel O’Halloran, Chief Investment Officer, KBC Asset Management and Jim Power, Chief Economist, Friends First.

Niall Dunne,
Treasury Economist, Ulster Bank

• Eurozone
Last August we made headlines by warning of two rate hikes in the space of 12 months, and gradually over the autumn this view became the consensus. And we’re holding with our view – the first rate hike has already been delivered, and by our reckoning, another can be expected in the first half of 2006, most likely in February or March. The ECB has embarked on a process of policy normalisation, which will likely take the refi rate to 3 per cent over the next 18 months. Further hikes will be characterised as pre-emptive steps to tackle pipeline inflationary pressures, pressures which the ECB will find in rapidly accelerating credit growth, no matter how anaemic overall economic conditions. So what to do? Mortgage holders with low loan-to-value ratios which qualify for tracker rates can probably ignore recent developments. However, for variable rate borrowers, we would suggest considering fixing at least a portion of outstanding debt, to protect against any possible oil-fuelled spike in inflation over the coming years. And for corporate treasures / business borrowers, while short-term swap rates have risen by 50 basis points over the past two months, we still see value further out the curve, particularly in ten year money, which can be made additionally attractive through structured solutions such as discounted swaps.

• US
Finally, in the US, we expect soon-to-retire Fed Chairman Greenspan to go out with a bang – Greenspan is likely to push US rates to 4.50 per cent before he steps down in January. Thereafter – the man with arguably the second-most powerful job in the world – incoming Chairman of the Fed Ben Bernanke – will be at the mercy of the man with the most powerful job in the world – President Bush. The more the White House spends, the more inflationary pressures will build in the US. We expect Bernanke’s Fed to take rates to 5 per cent in 2006 to counteract the threat of inflation, although the hikes won’t be consecutive, and any pause in the tightening cycle could have serve repercussions for the dollar. However, if US rates do rise to 5 per cent, then monetary conditions will probably become restrictive in the US, so we would not be surprised to see some downward adjustments in US rates by the end of next year.

• UK
Looking to the UK, we expect rates to fall again in the New Year, although the Bank of England’s monetary policy committee is yet to recognise this reality. Consumer consumption remains anaemic in the UK, and early indicators for retail activity over the festive season look bleak. House price growth has decelerated dramatically, and the Chancellor of the Exchequer was recently forced accept that his growth forecasts for the current year were too optimistic. However, the Bank of England’s median forecast for UK 2006 GDP growth remains at the upper end of City forecasts. When the Bank of England is disappointed by GDP data in the New Year, then we think the Monetary Policy Committee will cut rates again.

Austin Hughes,
Chief Economist, IIB Bank

• Eurozone
The ECB has recently begun a process to bring Euro area rates away from the ‘emergency’ settings of recent years towards more ‘normal’ levels. While the Eurozone economy appears to be improving of late, it is still fairly sluggish. So, this will restrain the speed and scale of rate hikes through the coming year. That said, unless the Euro soars on FX markets, we are likely to see a sequence of rate hikes through 2006. The ECB sees inflation remaining above target for the next couple of years. On the basis of their economic models, it would take about a one percentage point rise in interest rates to return inflation to target. Many ‘traditionalists’ at the ECB probably feel it would take at least similar amount of tightening to dampen loan demand. By the end of next year, inflation should be under control and the global economic outlook more uncertain. So, the ECB is likely to be forced to pause the rate hiking process.

• US
Most recent economic data suggest the US economy continues to perform extremely well. Importantly, core inflation remains very well behaved and we don’t expect any notable deterioration in 2006 because price competition at both local and global level remains intense. We think two factors will cause the long US rate rising cycle to end and eventually open up the prospect of lower policy rates in around a years time. The first of these is the prospect that after several scares in recent years, the US consumer will finally begin to scale back spending. A softening property market could be a key driver in this regard. We also reckon that Alan Greenspan’s replacement by Ben Bernanke at the helm of the Fed will be important because Bernanke appears much more confident that the battle against runaway inflation has long been won.

• UK
The Bank of England’s August rate cut appears to have provided some support to consumer spending and to the property market - at least temporarily. We still feel the UK economy lacks significant forward momentum and could be vulnerable to setbacks. The jobs market is softening and we expect budget policy to restrain spending power again in 2006. Very weak manufacturing data of late suggest there is little sign of a ‘rebalancing’ of activity away from households towards businesses as Bank of England Governor Mervyn King had hoped. In these circumstances, we think inflation pressures will be very limited. So, the headline inflation rate should ease to or below the Bank of England’s target. For these reasons, we expect a couple of UK rate cuts in the coming year.

Oliver Mangan,
Chief bond economist, AIB Global Treasury

• Eurozone
The ECB looks to have embarked on a rate hiking campaign, even if it says further policy tightening is not pre-ordained. It obviously believes that policy remains exceptionally accommodative and is fuelling very strong growth in monetary aggregates. Thus, provided the upturn in activity in H2 2005 is sustained in 2006, further rate hikes can be expected. We see the refi rate rising by a further 50bps to 2.75 per cent by mid-2006. Thereafter, the ECB may pause for a while as inflation is likely to fall well below 2 per cent in H2 2006. Thus, rates may have nudged up just a little further to 3 per cent by early 2007.

• US
The Fed can be expected to continue tightening US monetary policy in the first half of 2006 given the prospect of further strong economic growth over this period. We believe that the with the rebuilding works following the damage caused by hurricanes set to get into full swing early next year, employment growth picking up again and inventories likely to be rebuilt after their recent rundown, GDP growth of 4 per cent or above is likely in H1 2006. Thus, the Fed is likely to push rates to 4.75-5.0 per cent by mid- year. Thereafter, policy may go on hold if the much heralded slowdown in the US housing market materialises, pushing economic growth back down to its trend rate or below.

• UK
The Bank of England is obviously reluctant to go beyond the 25bps rate cut of last August, even though the economy continues to grow below trend. However, with the CPI rate falling back towards 2 per cent again, a rate cut in early 2006 cannot be ruled out, especially if consumer spending remains sluggish over the Christmas period. Our forecast reflects this possibility but we are far from fully convinced that policy will indeed be eased. Thereafter, rates should remain unchanged, especially if recent signs of a revival in housing activity bear fruit next year.

Alan McQuaid,
Chief Economist, Bloxham Stockbrokers

• Eurozone
Many believe that higher Euroland interest rates will scupper the region’s nascent economic recovery, and there is no doubt that the ECB will have to tread carefully. A lot too will depend on what happens to the euro. It makes little sense in my view for the Bank to just raise rates once to 2.25 per cent, so on that basis rates are likely to rise to 2.50 per cent at least by the end of next year. There is no doubt that the ‘hawks’ on the ECB would like to see rates up to 3.00 per cent or higher as soon as possible and if the economy can withstand the first 50bps of tightening, then there is every chance we will get to 3.00 per cent by the close of 2006. The smart word in the financial markets based on ‘reliable’ ECB sources is that 2.75 per cent is the very minimum the Bank wants to achieve next year all things being equal.

As regards fixing your mortgage, I think the best deals have probably been missed at this stage. That said there appears to be still some good value out there in 1-3 year fixed rates. I would be reluctant to fix any longer than that because even though I am forecasting the ECB rate to be up at 3.00 per cent by the end of next year, I am not wholly confident in this prediction and could easily envisage a situation where the tightening process finishes before it really gets started as economic activity in Euroland weakens. As such, I would be inclined to wait for about six months myself before deciding whether to fix or not. By that stage we should have a better idea as to how the Eurozone economy is performing and the extent of underlying inflationary pressures.

• US
The US economy remains solid and the longer it remains firm the more likely the Fed will continue to raise rates. That said, inflationary pressures appear to be well contained and unless we have another oil price spiral, then the need for significant tightening from here is limited. I think we will definitely get two more 25bps rate hikes bringing the fed funds rate to 4.50 per cent by end-January when Alan Greenspan is due to leave office. Fed Chairman elect Ben Bernanke may want to earn his spurs early on pointing to another quarter-point increase to 4.75 per cent and after that it really is a case of whether further insurance is needed. But by the first quarter of 2007 the American economy should be slowing enough to warrant rate reductions.

• UK
The Bank of England rate outlook is probably the most difficult to call. The jury is still out as to whether the next rate move when it does eventually come will be up or down. But recent comments from Bank officials point to no great hurry to move rates from where they are at the moment (4.50 per cent). If economic growth recovers, as expected, and inflation falls back to its 2.0 per cent target or below, then there is every chance that the UK base lending rate will remain on hold for a prolonged period. However, if economic growth weakens then rates will fall further while if inflation remains higher than desirable then monetary tightening is the most likely outcome over the next twelve months or so.

Dermot O’Brien,
Chief economist,
NCB Stockbrokers

• Eurozone
Despite the impression ECB president Trichet may have given, the December 1 interest rate increase is not likely to be a once-off event. The ECB has embarked on a path of monetary tightening that is aimed, in the first instance, at cooling the pace of growth in private sector credit in the Eurozone and, within that, the rate at which mortgage credit is expending. This will clearly require more than one rate rise. The speed at which the ECB moves from here will, however, be tempered by the likelihood that the Eurozone economic recovery will continue to be very gradual. For that reason, we believe action in 2006 will not be aggressive. For choice, we think the ECB refinancing rate will end next year at 2.75 per cent. A 3 per cent end-2006 level is a possibility but anything higher than that seems unlikely.

• US
In the US, the Fed has already brought interest rates 300 basis points off their lows and the minutes of the November meeting of the Federal Open Market Committee suggested that opinion within the body is growing that the end of the US monetary tightening cycle is coming. Before that happens, however, we think US rates have a further 75 basis points to rise. Having ended 2005 at 4.25 per cent, therefore, the Fed funds target rate will be hiked at each of the FOMC meetings in Q1 2006. Barring a spike in core inflation, which seems unlikely, the Fed will then go into a holding pattern that should last through to Q1 2007. We think the pace of growth in the US economy should remain robust and this will preclude any reduction in rates on the forecast time horizon.

• UK
In the UK, there are still some lingering hopes that base rates will be cut in the New Year. We do not, however, subscribe to this. The August 2005 rate cut was not very well based and we doubt Bank of England policymakers will be able to make a convincing case for a cut over the forecast horizon. Despite a lacklustre performance in 2005, the likelihood is that UK economic growth will strengthen next year. Underlying conditions favour a resurgence in consumer spending what with low unemployment and real wage growth. The emerging turnaround in the UK housing market is likely to contribute positively through its impact on consumer confidence. Stable base rates at 4.5 per cent seem the most likely for 2006, with the bias upward thereafter.

Noel O’Halloran,
Chief Investment Officer, KBC Asset Management

• Eurozone
The ECB have clearly commenced their ‘normalisation’ of rates. December 2005 was to the ECB what May 2004 was to the Federal Reserve, the beginning of taking back the accommodation of easy policy and cheap interest rates. With Euro zone headline inflation over 2 per cent in 2005, this makes it 6 years in a row where inflation has exceeded their target of slightly below 2 per cent. This combined with evidence of strong liquidity growth, very strong property markets emerging around the continent, and continuing in economies like Ireland and Spain, evidence of loan growth picking up strongly is sufficient for them to justify their continued gradual raising of rates towards neutral of 3.5 per cent sometime in 2007. The biggest challenge facing the ECB is a PR challenge where they will most likely have to defend each rate rise, particularly versus EU Finance ministers who will likely decry each move.

• USA
The economy should grow at or slightly above trend next year of 3.5 per cent. The Federal Reserve at 4.5 per cent will have completed its ‘normalisation’ process or neutralising rates that they have stated since May 2004 to be ‘accommodative’. I expect that the Federal Reserve will then wish to tighten monetary policy and hence move a further two times past 4.5 per cent to 5.0 per cent and finish there. The risk to this forecast I would expect be to the upside, which would occur should the economy continue to expand at a greater pace than expected or should inflation exceed expectations meaningfully.

• UK
I expect the Bank of England to be the least active of the three Central Banks, primarily because the starting points for UK rates are much higher. With the economy growing below potential, it is likely that the next move will be downward to 4.25 per cent and then back up to 4.5 per cent by end 2006

Jim Power,
Chief Economist, Friends First

• Eurozone
The increase of 25 basis points in the ECB base rate in December 2005 clearly highlights concerns within the ECB about the potential for inflationary pressures. It is concerned about strong monetary growth, a prolonged period of low interest rates and oil prices. The clear recovery in most Euro Zone economic indicators in recent months, albeit from low levels, is certainly now lending support to the ECB’s changed stance towards interest rates. If the ECB is concerned about inflationary potential, which it clearly is, then one rate increase would not be sufficient to quell those pressures. Consequently, there is a high probability that the ECB will tighten further during 2006 and prudent financial planning should allow for the possibility of combined tightening of between 50 and 75 basis points over the coming year.

• UK
In the UK, the Bank of England is likely to respond to the significant easing of house prices and general economic activity in recent months, and the probability of fiscal tightening over the coming year, by cutting rates further during 2006. In the US, the period of rising interest rates is not yet over and the Federal Reserve is likely to deliver a further tightening of 75 basis point, before it achieves what it would regard as an appropriate interest rate stance.

Given the likely trajectory of short-term rates in the UK, there would not appear to be a strong case for fixing in that market. In the Euro Zone, long-term rates have edged higher in recent months and the optimum time to fix would appear to have passed. However, for risk averse or heavily exposed borrowers, the insurance of fixing still offers reasonable value, unless the Euro Zone recovery runs out of steam. The most likely scenario is that growth will continue to gather momentum and long-term rates would appear to have further upside potential.

Digg.com Del.icio.us Stumbleupon.com Reddit.com Yahoo.com

Home | About Us | Privacy Statement | Contact
©2024 Fintel Publications Ltd. All rights reserved.