Lloyds TSB – International Financial Markets Outlook – April 2008

We believe the Bank of England brought forward its recent interest rate cut to head off the risk that a likely sharp near-term upturn in inflation would have made it more difficult in coming months and because the credit crisis intensified.

Recent measures by the Fed to boost liquidity and improve the functioning of financial markets suggest that such direct initiatives are now more likely than continued aggressive cuts to official US interest rates.

Summary of main changes to exchange rate forecasts

We believe the Bank of England brought forward its recent interest rate cut to head off the risk that a likely sharp near-term upturn in inflation would have made it more difficult in coming months and because the credit crisis intensified.

Recent measures by the Fed to boost liquidity and improve the functioning of financial markets suggest that such direct initiatives are now more likely than continued aggressive cuts to official US interest rates.

Signs of stronger US economic growth are the most crucial to the dollar’s prospects and the key to a sustainable recovery. We expect these from the second half of 2008 and so look for a strong rebound in the currency over the next 6-18 months. We predict €/$ at 1.50 and £/$ at 1.90 at end-2008.

The UK’s external deficit relative to the size of the economy has risen and suggests the currency could fall even further before stabilising. We look for downward pressure to remain on £/€ in coming months and have also changed our long-run equilibrium range to 1.20 – 1.30 for the exchange rate.

Conditions in credit markets remain challenging and we expect global central banks to introduce further measures to bolster liquidity. However, spreads between official and interbank money market rates are likely to remain abnormally wide for at least the remainder of this year though narrowing.

 

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