International Financial Outlook November 2010 Print
Long Term Forecasts | Written by Lloyds TSB | Nov 08 10 20:16 GMT

International Financial Outlook November 2010

Summary of main changes to exchange & interest rate forecasts

The US Federal Reserve has announced it will purchase a further $600bn in longer-term Treasury securities by end- Q2 next year. This follows an assessment that progress towards its objectives of price stability and maximum employment has been 'disappointingly slow'. In response, the US dollar weakened significantly against the euro, although it has regained some ground. While the first increase in the federal funds rate still seems some way off, encouraging prospects for economic growth mean we retain a positive stance on the US dollar further out. Our end-2011 forecasts versus the euro and pound are unchanged at 1.20 and 1.43, respectively.

Activity in the euro-zone continues to hold up well, driven by strong growth in Germany. But sustainability remains an issue, given the need for fiscal consolidation. Importantly, there are still major concerns over the health of public sector finances in 'peripheral' countries (e.g. Ireland). Although 3-month euribor has recently risen above 1%, this seems to reflect the withdrawal of liquidity compared with a year ago. With market conditions still volatile, we see the ECB keeping its main policy rate on hold at 1% for most of next year and forecast a first 25bp rate rise, to 1.25%, in 2011 Q4.

The Bank of Japan (BoJ) has left its overnight call rate at 0.0-0.1%, but announced further stimulus measures with part of its new ¥5 trn asset purchase programme being used to buy Japanese real estate investment trusts. The yen has hovered close to a 15-year high against the USD, but we expect a weaker trend to emerge as the US recovery strengthens. Our end-2011 forecast for USD/JPY has been raised to 107, from 101 previously.

In the UK, for the second successive quarter, the strength of economic growth has surprised most economists. The resilience of growth has sharply reduced the probability that the Bank of England will agree to additional asset purchases this year. However, we expect signs of slowdown and ongoing weakness in the monetary aggregates to lead to a resumption of QE in 2011.

The Reserve Bank of Australia delivered a surprise 25bp hike in its cash rate, to 4.75% earlier this month. Looking ahead, we see the next move coming in Q1 next year, most likely in February, en route to at least 6% by end- 2011. The AUD recently broke parity against the USD but going forward, we envisage a pull-back, with our end- 2011 forecast at 0.92.

In the past month, the risk of more emerging market countries introducing currency controls has seen most currencies remain range bound. And in the case of the Brazilian real, the increase in taxes on foreign capital has seen a small reversal in the currency's appreciation. Nevertheless, with interest rates at near zero in a number of developed economies, attractive yields are likely to remain supportive of emerging market currencies.

In China, the PBOC announced a surprise hike in both the deposit and prime lending interest rates in mid-October. This saw the fastest appreciation in the yuan since the end of the peg in June come to a grinding halt as the PBOC stepped in to ward off speculative capital inflows. Looking ahead, we expect this action to be temporary with a moderate CNY appreciation forecast over 2011. We have lowered our target for USD/CNY to 6.25 at end-2011.

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