- 2-year rates below 1%
- Euro / dollar likely to fall
Market interest rates in the euro area are currently at fresh historical lows following further declines in recent weeks; 2 year swap rates are now below 1% and the 5-year equivalent has slipped below 1.4%. The interest rate available on German bonds, deemed the safest home for euro funds, is lower still, with 2-year yields falling below 0.1%, while overnight interest rates in the money market are down around 0.3%, according to Bank of Ireland’s Monthly Bulletin published today, 04 May 2012.
Author of the Bulletin, Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland said: “One factor is the ECB, with the supply of over €1,000bn in 3-year funds to the market testimony to the central bank’s desire to avoid a credit crunch. The demand for loans is unusually weak however, in turn reflecting the limp nature of economic activity across the euro area; GDP contracted by 0.3% in the final quarter of 2011, and the available indicators imply that GDP fell again in the first quarter of 2012, so indicating that the euro area has accompanied the UK into another recession. Moreover, the consensus does not envisage a rapid or strong turnaround, with another decline in GDP projected for the second quarter followed by a flat reading in Q3 and a modest advance in the final quarter of the year.
“Interest rates are very low in most of the major economies of course, and expected to remain there for some time – the US Federal Reserve has stated that it expects rates to stay at the current exceptional levels until end-2014. The ECB has not made any such forward-looking statements but the market is also expecting euro rates to stay low over a similar timeframe.
“These market rates are not effective rates for many banks across the euro area however, as they have to pay a high credit premium to attract market funds, if indeed they can access the wholesale markets. Retail rates are often much higher, therefore than these market rates imply. Furthermore, some loan rates are directly linked to the ECB’s repo rate, including the majority of mortgage loans in Ireland, so to benefit such borrowers need to see a further cut in official ECB rates. That may occur, but the ECB may also take the view that market rates are low enough, and that a repo cut may not have much market impact. In a broader context, euro rates have also fallen relative to sterling and dollar rates which may help explain the single currency’s recent depreciation against the former to below 82 pence. One puzzle though is the euro’s resilience against the dollar, as the interest rate differential points to a foreign exchange rate of around $1.25, and we expect the euro to weaken over the coming month.”, concluded Dr. Dan McLaughlin.
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