International Financial Outlook November 2011
Financial Market Review - last month
Key proposals following the eagerly awaited EU summit helped to push €/$ briefly through 1.42, from 1.32 at the start of October, but the rally was short-lived. Political tensions reached fever-pitch as Greek PM Papandreou unexpectedly called for a referendum on the bailout package. After heightened concerns and renewed volatility, reflecting the potential implications of the referendum, Mr Papandreou withdrew the proposal and later stepped down from office to allow for a new unity government led by Lucas Papademos to be formed. However, market worries switched to Italy as its borrowing costs came under strong upward pressure, pushing 10yr yields briefly above 7%. This eventually told on PM Berlusconi who stepped down to allow a new technocratic government to be formed led by Mario Monti. However, while Italian yields have fallen, the focus has turned to Spain (6%) and France (3.4%). Increased signs of weakening growth saw the ECB unexpectedly cut interest rates to 1.25% in November.
GDP growth firmed in the third quarter in the US, UK and Japan. However, more timely indicators, such as the PMIs, showed the pace of growth faltering. Reflecting this, the BoJ expanded its asset-purchase programme by ¥5tn, while the October BoE MPC minutes showed the decision to restart asset purchases was unanimous; and the latest FOMC meeting had a distinct bias towards further easing. Benchmark bond yields tracked lower. Pressure on governments for short-term policy support has also grown. However, the supercommittee discussions in the US appear to be faltering and progress with the President's 'jobs plan' has stalled. In contrast, the third emergency budget ($156bn) was approved in Japan's lower house, while the BoJ intervened again to weaken the yen in October.
In the emerging markets, USD/INR rose above 50 for the first time since May 2009 on concerns about inflation and growth, while slowing Chinese CPI inflation raised hopes of monetary easing in the coming months.
Summary of main forecast changes
- We expect the ECB to cut the refinancing rate at its December meeting to 1%. The next move after this is expected to be a hike in Q1 2013. Much weaker economic growth expectations are reflected in our latest interest rate forecasts, with the 10yr bond yield and 5-year swap rate targets cut to 2.4% and 2.5%, respectively, at end 2012.
- End-2011 targets for GBP/USD (1.57) and EUR/USD (1.35) have been raised to reflect their current levels and market conditions, with some stability around political developments in the euro area likely to keep major currencies in tight ranges near term. However, we still expect a combination of weak growth data and monetary policy easing to weigh on both the euro and the pound in the year ahead.
- We forecast the RBA to cut interest rates in Q1 2012, to 4.25%.
- Targets for USD/BRL and USD/TRY have been lowered in the forecast horizon. However, USD/INR and USD/CNY are higher near term.
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