The pressure on Portugal is building

(06.04.2011) The euro has weakened as market participants focused on how interest rate hikes may affect debt burdened European countries negatively. Portugal is among these countries and market participants are increasingly expecting that Portugal will have to receive a bail out from EU/IMF.

By Camilla Viland, Analyst at DNB Markets

Expectations of European interest rate hikes have strengthened the euro lately. A 25 basis points hike on Thursday seem to be totally discounted in the market. Yesterday, however, attention turned to how higher interest rates would harm debt burdened European economies. Portugal is among the countries struggling with high debt and beliefs grow that the country needs an international rescue to fend off a sovereign debt default. The yield on Portugal five year debt yesterday rose to 9.91 per cent. Measured by CDS prices, the probability of a default is now 40 per cent. A first test will be on Wednesday when Portugal is auctioning EUR 2 billion in short term bills. The country is expected to manage to raise the money, but the interest rate is likely to be very high. A bigger test will be in June when EUR 7 billion in debt and interest rate redemptions mature.

The oil price rose yesterday. One barrel of brent oil currently costs about 120 dollar. The increase in the oil price comes as a result of increased demand for oil as the global economy gradually recovers. At the same time conflicts in Africa and the Middle East reduces the amount of oil available to markets. The latest now is supply disruption in Gabon due to oil strikes. Gabon is a relatively small oil producer, but as the problems arise at a time markets are very sensitive and on top of already ongoing conflicts in Libya and other oil producing countries in the Middle East, it affects the oil price. The high oil price is positive for Oslo Børs which rose yesterday. The NOK has however been relatively stable over the last 24 hours.

The Swedish krona did on the other hand weaken yesteday. A speech by Karolina Ekholm from the Swedish Riksbank contributed to the development. In the speech she said that if Swedish interest rates rose more than international rates, the Swedish krona could strengthen more that the Riksbank anticipates in their forecasts. Furthermore she said that further SEK strengthening could dampen both inflation and resource utilization. According to Ekholm, a further appreciation of the Swedish krona would thus risk leading to impaired target fulfilment, justifying a lower repo rate path than that decided upon in February. She also pointed out that, even though there is no target level for the exchange rate it is of fundamental interest to the Riksbank’s analysis work as it is an important determinant for both inflation and resource utilisation. Even though the market seemed to react somewhat to the speech, Ekholms views should not come as a big surprise. She entered a reservation against the interest rate decision and repo rate path at the Riksbank's monetary policy meeting in February. She wanted the interest rate to be left on hold and the interest rate path to be lower.

Private consumption has pulled European growth up lately. However, considering high unemployment, low wage growth and fiscal tightening the development is expected to be poorer going forward. Today figures for retail sales in February are released. In January retail sales grew by 0.4 per cent m/m. This time consensus expects a weaker outcome (0.1% m/m). Out of today's US key figures, the ISM index for the services industry seem to be the most important. Last month the index climbed to 59.7, the highest level since 2005. This time consensus expects an outcome of 59.8. Furthermore the minutes from the last FOMC meeting are released today. The minutes will be read closely looking for new signals as to when the Fed will start normalizing monetary policy. We do not believe that any new signals will be given and expect QE2 to continue as planned.