Market Opinion Interest Rates Conflicting Forces
At the moment, even despite the uncertainty surrounding the economic outlook in the US, due to the effects of Hurricane Katrina, it seems reasonable to assume that US interest are still heading higher over the coming 12 months. However, the outlook for interest rate direction in Europe, and particularly in the UK, is far less certain.
In euroland, there are clear upside pressures to inflation, stemming primarily from robust money supply growth and from oil prices. However, the recovery in economic activity across the board is still somewhat fragile to say the least, with Italy in fact flirting with recession. In addition, the German revival will encounter some major headwinds without progress on reform. Against this backdrop, we can see the ECB refinancing rate staying at 2.00% from some time yet. As a result, this should keep euribor contracts bids. The technical picture though looks a little weak at the moment. Looking at the June 2006 contract, if it breaks below 97.68, we see a further decline to major support at 97.60. We would expect this level to hold. However, as we have been saying over recent weeks, any drop through this level would make us bearish this contract.
As for sterling interest rates, there are a number of conflicting forces at play too. The technical picture of the June 2006 short sterling contract is bearish, with the price looking like it can head from its current level around 95.58 towards key support at 95.45. From a fundamental perspective, consumer spending – a key driver of the UK economy – is on the back foot, and yet inflation is on the rise. With oil price pressures still weighing, official CPI could well rise above 2.5% in coming months. However, it must be remembered that the CPI reading, as opposed to the old RPI-X number, does not include housing costs and is therefore far more sensitive to movements in the oil price. The old RPI-X measure has stayed around 2.3%, highlighting too the recent calming in the UK housing market. As a result, much depends on oil prices. An obvious statement perhaps, but even more relevant to the new reading of UK CPI, which actually has doubled over the past 12 months in line with Brent crude.
Despite the short-sterling market, we feel that while the Bank of England may well be on hold for a while, the next move will not be up. Still, you cannot ignore the price action.
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