Forex Magnum


International Financial Outlook November, 2009

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Summary of main changes to exchange & interest rate forecasts

Foreign exchange rate volatility remained fairly intense last month. Interest rates were calmer but here too tensions have increased, as financial markets give more thought to when some of the extraordinary loosening of monetary policy seen over the last year will start to be reversed. On the foreign currency front, increased signs of economic recovery are generally keeping the US dollar under selling pressure. Some countries have already started to raise interest rates, like Norway and Australia (the latter twice in as many central bank meetings). More countries will follow in the months ahead. On the basis of our forecast that global economic recovery is being led by the emerging market countries, we look for a number of these to hike rates in early 2010. Looking at gdp figures so far for Q3, which showed doubledigit annualised increases in Singapore, South Korea and China, we would not be amazed if these countries were amongst the first tranche that either raise rates or signal an increase.

Interestingly, our forecast bias is that those currencies that have seen interest rate hikes or are expected to see them soon, will appreciate the most versus the US dollar over the year ahead. Admittedly, this is not all emerging markets, but those that have the strongest growth potential and are also benefiting from an increase in commodity prices. This list would include Brazil, Russia and South Africa. Also, on our list are those less well-known South Asian economies that are tied in to the Chinese growth story, like Indonesia, Vietnam and the Philippines.

Looking at the developed economies in more detail, however, our forecast shows the US dollar regaining strength as we go further into 2010. The reason is that the US economic recovery in our central case is relatively robust for an advanced economy. Growth in the US is likely to be in the 2% plus range in 2010, whereas for the advanced economies as a whole the average growth rate is 1.3%. Against the euro, we project that the US dollar appreciates aggressively in Q2, reaching $1.37 by mid-year and $1.27 by end-year. One reason why US interest rates rise more than elsewhere is that they are so low already, but they will be in line with, or above, the euro rate possibly by the end of 2010.

For sterling, UK economic recovery has so far been slow, and so it has been held back, though the signs are that growth could resume on the official estimate in Q4 2009. Such an outcome may be good news for sterling but it will have to contend with uncertainty generated by parliamentary elections in the first half of the year (they have to be held by June). In addition, the VAT hike in Q1 could lead to activity being brought forward into Q4 of this year. Higher oil prices and price inflation, as a result of the higher VAT rate, could hit real incomes and spending in early 2010.

Lloyds TSB Bank

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