Interest Rates
Euribor Retreats
Our bearish view of the June 2006 euribor contract has played out well, thus far. Having first promoted the opinion at the beginning of October, the price has dropped from 97.58 to a low at one stage last week of 97.41, before bouncing to 97.47. Not a huge move, of course, and nothing like the wild swings in interest rate markets of yesteryear.
But, a profit is a profit. Anyway, this is a market that continues to fascinate us. Deep down, we just cannot envisage the ECB upping interest rates more than 50bps next year, if at all in fact. Real GDP growth continues to disappoint, and is likely to register just 1.2% this year. We are hearing much optimism for a rebound in 2006, but we don’t buy it. These same people are talking about a US, and perhaps global slowdown, due to high oil prices. But, if this happens, the export-dependent markets of the EU, and Germany in particular, are bound to take a hit. As such, we are concerned about the effects of rate hikes on the German and Italian economies.
Yet, as we have said before, this game is all about second guessing central bankers. And the ECB appears like it is itching to pull the interest rate trigger. The final reading for E12 September inflation of 2.6%, up from 2.2% in August, hardly helped matters. As a result, the hawkish comments came thick and fast. President Trichet stressed that the ECB would act decisively on any signs of second round effects, while chief economist Issing claimed that words alone would not keep inflation in check indefinitely. With core inflation rising to 1.4% from 1.3% last month, the time for action may be coming closer. That said, Issing did qualify his remarks somewhat, by saying that action would be required if risks for price development in the medium term increase further. As such, this could mean that any hike will not materialise until sometime in Q106 at the earliest.
Furthermore, this week’s flash estimate for October inflation should dispel some immediate concerns, with consensus forecasts putting the figure at 2.4%, down from 2.6%, heralding the first deceleration since May.
With this in mind, and in light of the end of week bounce, June euribor could edge a little higher over the coming days. Short-term resistance exists at 97.525, a break of which would set up a return to major resistance at 97.59. However, although we adhere to a near-term bounce, we believe the medium-term trend is still lower. A move through 97.41, sets up declines towards the 97.20 area.
As for short-sterling, the conundrum between the fundamentals and the technicals continues. Looking at the chart, the June 2006 contract appears weak, having broken the 95.53 level, to close at 95.49. Major support exists at 95.45, a break of which would be a highly negative signal. Yet this would imply a three-month interest rate of over 4.50% by June next year. We still find this hard to fathom. True, retail sales data bounced last week, but inflation surprised on the downside. UK CPI rose by 0.2% m-o-m in September, with the y-o-y rate moving up to 2.5%, as opposed to the 2.6% that had been generally forecast. Although the headline figure is still above target, the core rate at 1.7% y-o-y remains relatively benign. Furthermore, the economy grew by just 0.4% q-o-q during Q305, or 1.6% y-o-y. This is way below Mr Brown’s forecasts, which will leave his budgetary estimates somewhat awry.
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