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Forex and Interest Rate Outlook
23rd October 2014
AIB Treasury Economic Research Unit
Global growth disappoints yet again this year. Moderate growth in most economies, but
activity in eurozone remains very weak. Very low inflation in many countries
ECB retains an easing bias and pressure remains to do more, given weak state of economy
Dollar and sterling rallies halted as markets are hit by risk aversion and scale back their
expectations about the timing and extent of rate hikes in US and UK in 2015/16
Further sharp drop in benchmark bond yields on a flight to quality, driven by heightened
risk aversion as investors fret about global growth prospects and low inflation
Monetary tightening still looks likely in US and UK next year, which should favour their
currencies but would pressure bond markets given current very low yield levels
Oliver Mangan
Chief Economist
John Fahey
Senior Economist
www.aibeconomicresearch.com
Dara Turnbull
Economist
Global Economic Outlook
Global Composite PMI (JP Morgan)
Concerns mount about persistence of weak global growth
65
It has been clear right through this year that bond markets have major doubts about the durability and strength
of the recovery in the world economy. This is evidenced by the decline in bond yields everywhere since the start
of the year. Equity markets, though, have been more positive, boosted by good data in some economies like the
US and UK. Low interest rates and further easing by the ECB have also helped sentiment in stock markets.
Concerns about the weak recovery of the global economy have gained the upper hand on financial markets in
recent weeks. There has been a flight to quality into major bond markets, while equity markets have been
60
55
50
45
volatile, suffering large falls on occasions. A number of factors have been behind the markets growing concerns.
There was a downbeat assessment of the global economy from the IMF, some soft data in the US and UK, very
40
weak, recession-type figures from the Eurozone and a further plunge in oil prices that added to deflation fears.
There are real worries that the world economy may be facing a prolonged period of low inflation and weak
35
Sep-05
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
growth, reflecting structural rather than cyclical factors. These include ageing populations and slow labour force
Sep-12
Sep-13
Sep-14
Source: Thomson Datastream
growth in many developed economies, as well as a slowdown in technological advancement and thus weaker
productivity growth. Meanwhile, there are few signs of badly needed structural reforms being implemented that
would boost the growth prospects of the under-performing Eurozone economy, most notably in countries like
GDP (Vol % Change)
World
2012
3.4
2013
3.3
2014 (f)
3.3
2015 (f)
3.8
Advanced Economies
US
Eurozone
UK
Japan
1.2
2.3
-0.7
0.3
1.5
1.4
2.2
-0.4
1.7
1.5
1.8
2.2
0.8
3.2
0.9
2.3
3.1
1.3
2.7
0.8
Developing Economies
China
India
7.7
4.7
7.7
5.0
7.4
5.6
7.1
6.4
Advanced Economies
Inflation (%)
External Trade (Vol %)
2.0
2.0
1.4
2.4
1.6
3.6
1.8
4.5
France and Italy.
Furthermore, we may be at the end of the phase of rapid growth in emerging economies, most notably China.
On top of this, the legacies of the 2008-09 financial crash, including much tighter credit conditions and prolonged
deleveraging to reduce high debt levels, are also dampening growth. It is not that surprising then that financial
markets are increasingly worried that weak growth and low inflation may be the new paradigm for the world
economy.
AIB Treasury Economic Research Unit
Nevertheless, the IMF and OECD still expect an improved performance by the global economy next year. The IMF
is forecasting that the world economy will grow by 3.8% in 2015 up from 3.3% in the past three years. Growth
in advanced economies is forecast at 2.3% next year, having averaged a very modest 1.5% over the period
2011-2014. In particular, growth in the US economy is forecast to pick up to around 3% in 2015. However, the
Eurozone and Japanese economies are expected to remain weak, continuing to lag well behind elsewhere.
The further loosening of monetary conditions this year and less restrictive stance of fiscal policy are seen as
important factors in boosting global growth prospects. Somewhat ironically, the sharp drop in oil prices and
marked fall in long-term interest rates, as a result of concerns about weak global growth, should help boost
activity too. Labour market conditions are also improving, with employment rising and unemployment falling in
all the main economies this year. We note also that the Global Composite PMI hit a four-year high in Q3 2014,
suggesting that the world economy is improving. The fear of markets, though, is that, notwithstanding these
favourable factors, expectations of stronger global growth will be disappointed yet again in 2015.
Source: IMF World Economic Update October 2014
Interest Rate Outlook
US Interest Rate Forecasts (to end quarter)
Markets scale back rate hike expectations in the US and UK
The ‘Great Recession’, and the sluggish and uneven pace of recovery from it, saw the main central banks cut
interest rates to record low levels, as well as employ non-standard monetary policy easing measures, including
QE and forward guidance that interest rates could remain at low levels for a prolonged period. Central banks
have been keen to give the fragile recovery in the world economy every chance to gain traction.
Fed Funds
3 Mth
1 Year
2 Year *
5 Year *
Current
0.125
0.23
0.54
0.64
1.62
Continuing weak economic conditions in the Eurozone saw the ECB cut rates twice in 2013. A fall in inflation to
well below 1% prompted the ECB to loosen policy even further in June and September of this year. It cut its key
refi rate to just 0.05% and moved the discount rate into negative territory. It also announced a broad range of
measures to boost market liquidity and bank lending, including TLTROs and an asset securities purchase
programme, in effect quasi quantitative easing.
Dec '14
0.125
0.25
0.55
0.65
1.65
Mar '15
0.125
0.25
0.60
0.75
1.75
June '15
0.125
0.35
0.75
0.90
1.95
The ECB retains an easing bias and has indicated that it is prepared to loosen policy further if risks grow of a
prolonged period of very low inflation. It has indicated, though, that official rates have reached a trough. ECB
rates are expected to stay at virtually zero for an extended period of time. The markets are not anticipating any
increase in rates until end 2017 at the earliest, and do not foresee rates rising to 1% before end 2020.
* Swap Forecasts Beyond 1 Year
By contrast, both the Fed and BoE had to temper their forward guidance on rates staying low in the face of
better economic activity and, in particular, a much faster than expected improvement in their labour markets.
The US Fed is winding up its QE asset purchase programme this month. However, it has indicated that interest
rates will not rise for a considerable time, suggesting that rate hikes are still some time away in the US.
AIB Treasury Economic Research Unit
Meanwhile, in the UK, two MPC members have voted for an immediate rate hike at recent Committee meetings.
However, the majority view on the MPC is that with wage inflation falling to very low levels, CPI inflation well
below target and declining, and a weak external environment, the BoE can afford to be patient. Thus, as in the
US, rate hikes in the UK do not appear to be imminent either.
Indeed, markets have been scaling back their expectations recently on both the timing and scale of rate hikes in
the US and UK, in response to a further easing of inflationary pressures, low wage inflation and the continuing
fragility of the recovery in the global economy. The timing of the first rate hikes has been pushed back to Q3
2015. Furthermore, futures contracts now see UK and US rates rising to 1.25-1.5% by end 2016 compared to
2% or above, previously.
Obviously, the recoveries in the US and UK economies will need to be sustained for rate hikes to materialise. The
general expectation is that both economies will see strong growth again next year. This could see their
unemployment rates drop towards 5%. It is hard to see their Central Banks keeping interest rates at their
current very low levels is such circumstances, even if inflationary pressures stay very subdued.
Rate hikes, then, seem likely in the US and UK in 2015/16, although they are expected to prove very modest.
Nonetheless, it would represent an important change in monetary policy direction. It would also imply a marked
divergence in monetary policy globally. The ECB and BoJ are expected to keep rates at zero per cent for a long
time, in contrast to the Fed and BoE. Indeed, they could even ease policy further next year.
Eurozone Interest Rate Forecasts (to end quarter)
Refi Rate
3 Mth
1 Year
2 Year *
5 Year *
Current
0.05
0.06
0.31
0.22
0.49
Dec '14
0.05
0.05
0.30
0.25
0.50
Mar '15
0.05
0.05
0.30
0.30
0.55
June '15
0.05
0.05
0.30
0.35
0.70
* Swap Forecasts Beyond 1 Year
UK Interest Rate Forecasts (to end quarter)
Repo Rate
3 Mth
1 Year
2 Year *
5 Year *
Current
0.50
0.55
1.00
1.09
1.74
Dec '14
0.50
0.55
1.00
1.10
1.75
Mar '15
0.50
0.60
1.10
1.15
1.85
June '15
0.50
0.70
1.20
1.30
2.05
* Swap Forecasts Beyond 1 Year
Current Rates Sourced From Reuters, Forecasts AIB ERU
Forex Market Outlook
US Dollar Trade Weighted Index Versus Majors
Euro on weakening path but trading turns more volatile
(March 1973 =100)
90
The euro has lost ground in the past six months as the persistence of very weak growth in the Eurozone, coupled
with a fall in inflation to very low levels, forced the ECB into further policy easing in both June and September. It
has become increasingly clear that while interest rates are likely to rise, albeit modestly, in the US and UK over
the next couple of years, they are set to remain pegged at virtually zero in the Eurozone for a prolonged period
of time. This has put downward pressure on the euro, as has speculation that the ECB may have to do even
more policy easing, including a full-blown quantitative easing program.
It has been a steady decline by the euro rather than a sharp drop. Against sterling, the euro has fallen from
close to 84p in March to a 78-80p range in the recent months. The euro/yen rate has fallen from a high of ¥145
to ¥136. Meantime, the euro has also moved steadily lower against the dollar over the past few months, falling
from close to $1.40 in May to below $1.30 in September. It has generally traded in a €1.26-1.28 range in the
85
80
75
70
65
Oct-06
Oct-07
Oct-08
Oct-09
Oct-10
Oct-11
Oct-12
Oct-13
Oct-14
Source: Thomson Datastream
past month.
The depreciation of the euro this year highlights that a very important factor for FX movements presently is the
relative growth performances of economies and their inflation rates, which in turn are a major influence on the
respective monetary policies of their central banks. When uncertainty starts to creep in about monetary policy, it
can lead to a lot of volatility on forex markets, as we saw in the past couple of weeks.
AIB Treasury Economic Research Unit
Some weak data in the US and UK, as well as muted inflationary pressures, have seen markets push out the
likely start date for when the BoE and Fed would begin to hike rates. Markets also scaled back their expectations
of the extent of monetary tightening in the US and UK over the next couple of years. This has provided some
relief for the under pressure euro and yen currencies over the past fortnight. They have stabilised against the
dollar and sterling for now, but with trading turning quite volatile at times.
The much more positive outlook, though, for the US and UK economies vis-à-vis the Eurozone and Japan
suggests that fresh gains are likely for the dollar and sterling. In particular, there has been a marked tightening
in labour market conditions in the US and UK, with their unemployment rates falling to 6%. Their unemployment
rates could fall close to 5% next year. This would point to rate hikes in the US and UK in 2015.
The Fed and BoE may not be in any hurry to tighten monetary policy and have signalled that when rate hikes do
eventually start to come through, they are likely to prove modest. Nevertheless, both Central Banks seem likely
to increase rates next year if their economies continue to perform well. Markets expect rates in both economies
to rise to near 1.5% by end 2016. In contrast, markets are not discounting any rise in Eurozone rates until end
2017 at the earliest. This points to further upside potential for the dollar and sterling against the euro.
There is good technical support, though, for the euro around current levels. Although the euro dipped to around
$1.20 against the dollar on a couple of occasions in recent years, these proved brief episodes. The euro has not
traded below $1.26–1.27 on a sustained basis since 2006. We expect the market will eventually breach this level
if Fed rate hikes next year become increasingly certain. This could signal a move down towards $1.20 for EUR/
USD. However, it may be a slow process, with US rate hikes not expected until H2 2015 at this stage.
Euro / Dollar Exchange Rate
US$
1.45
1.40
1.35
1.30
1.25
1.20
Oct-12
Apr-13
Oct-13
Apr-14
Oct-14
Source: Thomson Datastream
US$
Sterling / Dollar Exchange Rate
1.75
1.70
1.65
1.60
1.55
1.50
1.45
Oct-12
Apr-13
Oct-13
Apr-14
Source: Thomson Datastream
Oct-14
Forex Market Outlook
BoE rate hike would give further boost to sterling
£
Euro / Sterling Exchange Rate
0.89
Good labour market figures as well as strong GDP data have seen futures markets discount for some time that
the BoE will start to hike rates in 2015. As a result, sterling has performed well over the past year or more.
Cable climbed from $1.50 to above $1.70 at one stage, before moving back down to around $1.60 over the
summer. Meanwhile, the euro has fallen from 87p in mid-2013 to a 78-80p range against the UK currency.
The recovery in the UK economy appears to be quite solid, while the labour market is tightening at a much
quicker than expected pace. The unemployment rate is now down to 6%. GDP growth is generally expected to
be close to 3% next year. A modest rise in rates looks to be on the cards in the UK for 2015 in such
circumstances. The market, though, has pushed out the timing of the first rate hike until after mid-year. Sterling
should make further gains against the euro if the BoE starts to increase rates in 2015.
There is very strong technical support for the euro, though, at around the 78p level vs sterling. Moving below the
78p level will be a stiff challenge as it would take sterling to levels not seen since early 2008. However, such a
move could well occur next year if it becomes clear that UK rate hikes are indeed at hand. We see the EUR/GBP
rate falling to 75-76p by end 2015 as interest rate differentials widen in favour of the UK currency.
0.86
0.83
0.80
0.77
Oct-12
Apr-13
Oct-13
Apr-14
Oct-14
Source: Thomson Datastream
Dollar / Yen Exchange Rate
Yen
115
110
105
Sterling fell back against a resurgent dollar over the summer, with cable declining to around $1.60. With both US
and UK interest rates expected to rise modestly in the next couple of years, trading in cable could now well settle
down and become quite range bound, as happened between mid-2010 and early 2013. Over that period, $1.551.65 contained virtually all the action in cable. We would not be surprised to see a somewhat similar trading
range re-established for cable in 2015.
100
95
90
85
80
AIB Treasury Economic Research Unit
Yen looks vulnerable if rates rise elsewhere
The yen fell sharply between late 2012 and end 2013 as a new Japanese government got the Bank of Japan to
embark on an aggressive easing of monetary policy. The yen slumped from ¥78 to ¥105 against the dollar and
from ¥95 to ¥145 versus the euro over this period. The yen, though, has been more stable this year. It did lose
some ground in the early autumn, with the USD rising from ¥102 to ¥110, a six year high. However, it has since
recovered some ground on a pick up in risk aversion in markets, which normally benefits the Japanese currency.
A weak economy and the marked expansion in Japanese money supply caused by the on-going QE programme
remain negative factors for the yen. Japan’s monetary policy will have to remain very loose for a long period.
Hence, rising interest rates elsewhere, especially in major markets like the US and UK, could see renewed
downward pressure on the yen. Thus, it would not be a surprise to see the dollar rise towards ¥115 during next
year. Against the euro, though, the yen may be able to largely hold its ground, given that Japanese and
Eurozone interest rates and their economic performances are likely to be very similar in 2015.
75
Oct-12
Apr-13
Oct-13
Apr-14
Oct-14
Source: Thomson Datastream
Euro / Yen Exchange Rate
Yen
150
140
130
120
110
100
90
Oct-12
Apr-13
Oct-13
Apr-14
Oct-14
Source: Thomson Datastream
Summary of Exchange Rate Forecasts
(“Spot” Forecasts for end Quarter can be taken as Mid-Point of Expected Trading Range)
Current
Q4-2014
Q1-2015
Q2-2015
Q3-2015
Euro Versus
Euro / Dollar Exchange Rate
US $
1.65
1.50
USD
1.267
1.24-1.30
1.23-1.29 1.21-1.27 1.19-1.25
GBP
0.791
0.77-0.81
0.76-0.80 0.75-0.79 0.74-0.78
1.35
1.20
1.05
JPY
136.19
134-140
134-140
135-141
135-141
CHF
1.21
1.21
1.21
1.21
1.21
0.90
0.75
Oct-00
Oct-02
Oct-04
Oct-06
Oct-08
Oct-10
Oct-12
Oct-14
Source: Thomson Datastream
US Dollar Versus
Euro / Sterling Exchange Rate
Stg
JPY
107.52
105-111
106-112
108-114
110-116
GBP
1.602
1.58-1.64
CAD
1.12
1.12
1.13
1.14
1.15
AUD
0.88
0.88
0.87
0.86
0.85
NZD
0.79
0.79
0.78
0.77
0.76
CNY
6.12
6.11
6.09
6.07
6.05
1.00
0.90
1.58-1.64 1.58-1.64 1.58-1.64
0.80
0.70
0.60
0.50
Oct-00
Oct-02
Oct-04
Oct-06
Oct-08
Oct-10
Oct-12
Oct-14
Source: Thomson Datastream
Sterling / Dollar Exchange Rate
US$
AIB Treasury Economic Research Unit
2.2
Sterling Versus
2
JPY
172
174
176
179
181
CAD
1.80
1.80
1.83
1.84
1.85
AUD
1.82
1.83
1.85
1.87
1.89
1.8
1.6
1.4
1.2
Oct-00
NZD
2.04
2.04
2.06
2.09
Oct-02
2.12
Oct-04
Oct-06
Oct-08
Oct-10
Oct-12
Oct-14
Source: Thomson Datastream
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