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News : Irish Last Updated: Apr 24, 2009 - 5:31:05 PM

Bank of Ireland revises forecast period for 2 European Central Bank rate cuts to end year 2008
By Finfacts Team
Jan 25, 2008 - 10:26:58 AM

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Dan McLaughlin
The Bank of Ireland's Dan McLaughlin has revised his forecast period of two European Central Bank (ECB) rate cuts from the first half of 2008 to the full year.  McLaughlin had previously forecast late last year that US Federal Reserve cuts would force the ECB to cut its benchmark rate by 0.5% to 3.5% by June 2008.

“The past few months has seen a dramatic change in interest rate expectations, first in the US, then in the UK and belatedly, in the euro area”, said Dr McLaughlin, the Group Chief Economist, Bank of Ireland in his Global Markets research bulletin (access was to the Nov 07 issue at the time of posting this report) published today.

“The catalyst for this re-appraisal was a re-assessment of the economic outlook for the US and hence the global economy, with some commentators now predicting a recession in the States, rather than a further period of sub-trend growth. The housing market there has certainly deteriorated rather than stabilised and the credit crunch has prompted concerns that the banking sector, under pressure from sub-prime losses, will cut back on new lending. The labour market also appears to have weakened, having held up well for most of 2007, and any further softening could undermine the consumer. The Federal Reserve is worried, and although it believes a recession can be avoided, the scale of its concern was clearly demonstrated by the recent inter-meeting cut in rates, the 75bp reduction bringing the total fall in rates since September to 1.75%.

“The global economy has boomed in recent years, despite sub-trend US growth, but investors now fear that a full-blown US recession would have serious implications for world activity. Consequently, equity markets have tumbled, shipping rates have declined and commodity prices have started to weaken, including oil - the benchmark US crude has already declined by over 10% from its brief flirtation with $100. Indeed a move below $88.25 could signal further substantial falls, with $80 the first target.

“In fact, the near-term path of oil prices could be very significant for the economic outlook, as a fall in energy costs would boost real consumer spending in the US and hence lower the risk of two consecutive quarters of negative growth, the usual market definition of a recession. The US Government is intent on a fiscal package to boost activity, which may be supportive if timely, but the market now expects US rates to decline further, to 3% by end -January and to around 2.0% by year end. The UK market is also convinced that the Bank of England will have to embrace an aggressive easing stance and the futures market is pricing in a Bank rate of 4.5% this year, from the current 5.5%.

“This expectation, alongside other negatives for the UK economy, including increased political uncertainty, the Northern Rock debacle and a change in the tax code for non-residents, undermined sterling, which slid across the board, with the euro trading at over 76 pence at one stage. Sterling has rallied since and we expect some further gains against the euro because the market perceives a change in tack from the ECB, with euro rates now seen to be on the way down.

The Bank had talked of rate hikes but the rhetoric has shifted of late, at least for some Council Members, with more concern voiced about the outlook for growth and the need for the ECB to revise down its forecast for euro area economic activity in 2008. It was always unlikely that the ECB would raise rates against the current US backdrop, in our view, but the result of this new tone emanating from Frankfurt is that the market is now pricing in at least a half percent cut in ECB rates this year, bringing it in line with our forecast. This marked change in rate expectations has in turn weakened the euro, and we also expect it to trade lower against the US dollar and sterling in the coming months”, concluded McLaughlin.

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