International Financial Outlook - April 2009

Summary of main changes to exchange & interest rate forecasts

• It is clear that the credit crisis will not end until the 'toxic assets' issue is resolved. Progress has been made on this in the past month but a clear cut end to the crisis still seems some distance away. However, the trough of the economic downturn appears to be close, if data released in the last month are any guide. However, the recession still has a long way to go, with unemployment likely to rise strongly in most countries for some time yet. Hence, official policy will remain extremely loose.
• We remain of the view that the ECB will reduce interest rates to 1% in this quarter, while the continuing weakness of the euro zone economy suggests more unorthodox measures to ease credit conditions also cannot be discounted. A further reduction in interest rates is unlikely in the UK, but we expect quantitative easing to persist until at least 2010. Further monetary measures to help restart bank lending are also likely in the US. However, once clear signs of economic recovery emerge, money supply will need to be reduced aggressively and interest rates raised to maintain price stability. For now, quantitative easing policy will help support government bond prices, in spite of the massive rise in new issuance. However, volatility is likely to remain high, reflecting uncertainty about the inflationary impact of the measures and investor demand.
• Very weak data from Japan indicate that the economy has been hit particularly hard by the credit crisis and related collapse in global trade. We forecast the economy may contract by up to 8% in 2009 - the most in the G7. Our latest currency forecasts show the yen depreciating against its main counterparts, with $/Y rising to 110 at end Q1 2010 and £/Y at 150.
• We continue to forecast generalised US$ appreciation over the next 6-18 months, primarily reflecting the likelihood of economic growth outperformance by the US against the economies of its main trading counterparts over the next two years. Short-term prospects are more linked with developments in credit markets and interest rate expectations and so trading conditions are likely to remain volatile. We forecast €/$ at 1.23 at end-2009 and £/$ at 1.37.
• Emerging market currencies will remain influenced by credit market developments in the short term, however we expect the underlying fundamentals of economies to play an increasingly important role as the year progresses. India and China are among the few major economies we expect to avoid recession this year, which should support their currencies. We look for $/yuan to appreciate to 6.59 and $/rupee to 49.50 at end - Q1 2010. Positive trends in commodity prices should support the Brazilian real, South African rand and Russian rouble. We expect Turkey to negotiate a new loan accord with the IMF later this year, which should see further lira appreciation.

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