Rate rises in early 2010 dependent on economic recovery
Central Bank rates across the major economies are at extremely low levels, in many cases unprecedentedly so. In the US the Federal Reserve is maintaining the Fed funds rate in a corridor between zero and 0.25% while in the UK the Bank of England has cut the Bank rate to only 0.5%. Euro zone rates are higher, at 1%, but again the repo rate is also at an historic low according to Bank of Ireland’s July Bulletin which was published today, Wednesday 1 July 2009.
Author of the Bulletin, Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland said: Interbank rates have also followed official rates down, with 3-month cash in dollars at 0.6% against 1.1% for euros and 1.2% in sterling. These rates are still somewhat higher than might be expected given the historical relationship between market rates and central bank rates, implying that there is still a premium for cash in the interbank markets, but that premium too has fallen of late, and is substantially lower than apparent last autumn, post the Lehman collapse.
Interbank rates may have scope to fall further but official rates are now generally thought to be at a cyclical floor, which means that the next move will be up and it is the timing and scale of such action which is now exercising financial markets. Central Banks themselves seem to be in no rush to tighten monetary policy (or, in the current jargon, to pursue an ‘exit’ strategy’), and the Federal Reserve reiterated at its June meeting that it expects to keep rates ‘at exceptionally low levels for an extended period’. Similarly the Bank of England sees significant risks to the economic outlook and is still printing money in order to stimulate activity, although the UK data has generally surprised to the upside of late, implying that a return to positive growth may be at hand. Closer to home, the ECB thinks rates are ‘appropriate’ now and recently injected $442 one-year cash into the money markets, at a rate of 1%, which is not the action of a Bank set to tighten monetary policy any time soon.
The shape of the economic recovery will ultimately determine the timing of the first move up in interest rates, and so far the international data is generally consistent with a modestly-paced return to positive growth, rather than a surge in activity. Market sentiment in this regard is volatile, nonetheless, and data surprises, such as the much lower level of US job losses seen in May, can prompt a marked change in rate expectations. At the moment, then, the US market is fully priced for a quarter-point rate rise by February 2010, but rates there are still expected to be under 1% in a year’s time. In the UK the market is giving a low probability to a rate change before year-end but is fully discounting a move higher by the Bank of England in the spring. Similarly, the euro cash market is currently priced for the first move up by the ECB in March or April, although one should remember that the world economy will have to look a lot better than it does now for these moves to materialise,. concluded Dr. Dan McLaughlin.
1 July 2009
Dr. Dan McLaughlin
Group Chief Economist
Bank of Ireland Global Markets
Tel: 01 609 3221
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Bank of Ireland
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