New Forecasts

illustration: Norwegian krone

(19.09.2011) We now expect Norges Bank to postpone the first rate hike to March next year. In Europe we expect a Greek default followed by recapitalization of the banking sector and massive support buying of Italian bonds.

By Kyrre Aamdal

In line with our monthly evaluation of our forecasts we present today revised prognosis. While we based our August forecasts on modest improving financial markets, the situation has worsened. The Greek funding situation is still a problem. Market confidence regarding Italy and Spain has impaired. The increasing turmoil has raised various risk premiums in the markets in general and tightened funding possibilities for banks. Additional unrest and higher pressure on bank funding may enforce political action. The conflicts of interests between European leaders (and voters) are large and we expect the financial situation to worsen further before a solution is found acceptable. It is highly uncertain what may be done and when. A possible outcome may be a Greek default followed by a plan for recapitalization and restructuring of the banking sector in each Euro area country. A Greek default will likely be based on a view that Greece in the long term is insolvent. It will be important for European governments to ring fence the Greek situation. Market funding of Italian debt may disappear, and it is important to establish a plan for securing funding of Italian debt. This may involve massive support buying of Italian government bonds. With such a development we expect the ECB to cancel further rate hikes. On the other hand it will be important to secure confidence to the inflation target. We thus do not expect any rate cut from ECB, even though that would help debt loaded countries.
With unchanged rates from ECB, a turbulent fall and tighter lending standards we expect both Norges Bank and the Riksbank to postpone the next rate hike until next year. For the major central banks (USA, UK, Japan and Switzerland) we expect unchanged policy rates at least until mid-2013. Increased turmoil and a Greek default may bring long-term rates further down. But if the markets have confidence in the ring fence of the Greek debt failure and the recapitalization of the banking sector, long-term rates may raise significantly. In the foreign exchange markets EURUSD may decline on increased turmoil, but raise on a credible solution. On the longer term we expect EURUSD to decline on better growth perspectives for the US economy. Both the NOK and the SEK may suffer from increased turmoil in the short term.  The NOK and the SEK are no safe havens but we might see the currencies strengthen versus the Euro over time due to increased interest rate differential.
US stocks increased for the fifth day in a row Friday. With an increase by 0.6 per cent for the S&P 500 Friday, the benchmark index was up 5.4 per cent on the week. This was the best week since early July. Also in Europe the stock markets generally improved on Friday. Long-term Treasury yields however fell further Friday. Fixed income and stock markets thus may have viewed the risk situation differently. The EURUSD was relatively stable during the weekend, but fell in Asian trading this morning. When typing, the EURUSD is down 1.3 per cent from Friday morning. The EURNOK is roughly unchanged from Friday morning, but has strengthened 0.8 per cent versus the SEK. This morning European stock markets opened down.
Today there are no important key macro economic figures. Later in the week we have monetary policy meeting both in the Fed and in Norges Bank. We will return with previews on those meeting, but we do not expect rate changes in any of those meetings. Norges Bank, however, may signal that the Board have assessed an alternative with lower interest rates.