Summary of main changes to exchange & interest rate forecasts

Recent economic data from most countries suggest a sharp global recession is likely in 2009. Uncertainty about its potential depth and duration will lead to further monetary easing, particularly as the near-term threat of inflation has all but vanished.

Recent economic data from most countries suggest a sharp global recession is likely in 2009. Uncertainty about its potential depth and duration will lead to further monetary easing, particularly as the near-term threat of inflation has all but vanished. However, there is a risk that central bankers could shore up major problems for the future, as the fear of deflation could lead to overly loose policy. There is already serious debate about the use of quantitative easing measures should nominal interest rates fall close to zero in the months ahead.

 

Although we continue to predict that the US Fed funds rate will trough at 0.5% this month, the risk clearly is that it is cut to zero. We also expect the Fed to continue to expand its growing balance sheet, acknowledging that more targeted measures are crucial to easing tensions. In the UK, we now expect the Bank of England to cut interest rates by a further 100bp to 1% by Q1 2009, then holding them steady for the remainder of 2009. The bias again is skewed to the downside. The ECB may be reluctant to push interest rates much further lower, however we look for the repo rate to fall to 1.5% in early 2009, as the economic slowdown intensifies.

 

In the near-term, ongoing developments in credit markets are likely to remain the main driver of currencies, keeping volatility extremely high as risk appetite exhibits large swings. However, some recent market shifts have only confirmed several of our long standing predictions within the G10. Looking ahead, we continue to favour the US dollar against most of its main trading counterparts, projecting €/$ at 1.20 and £/$ at 1.38 at Q2 2009. Already at 13-year lows, the pound is forecast to depreciate further on a trade weighted basis in 2009.
 

 

Full Report

 

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