Weekly Commentary 17 February 2012

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1 Produced by the Economic Research Unit Corporate Treasury Business Banking Treasury Institutional Treasury Property and Specialised Finance (01) UK Sales Team (UK only) US Sales Team Full contact details for all departments click here ( Weekly Commentary 17 February 2012 Economic Research Unit: (01) Themes from the week Stronger data but Greece still impacting market direction Headlines for the week ahead Irish CPI, BOE minutes, IFO and Euro PMI Sterling swap rates rise on data and sign further QE less likely Sterling period rates rose following much stronger than expected retail sales data for January, with the 0.9% rise on the month pulling the increase over a three month period to 1.3% and reinforcing the view that the UK economy has recovered some positive momentum over the past few months after a weak period in the late summer and early autumn. The February Inflation report also nudged rates in a more bearish direction as the latest BOE forecasts show inflation following a higher path than in the previous report, albeit still modestly below the 2% target in early The BOE thinks the risks of an undershoot and an overshoot are balanced beyond that date however, which would perhaps imply that a majority of the members would not support a further round of QE beyond the 325bn total agreed in February. The degree of unanimity surrounding that decision will be of interest and will be revealed on Wednesday. Data section contents (changes on the week) Commodities Long term rates Highlights for the week ahead Prev Fcst Cons Tues UK PSNB $10.8bn - 9.1bn Wed UK BOE minutes Euro PMI US Existing Sales 4.61mn 4.66mn Thurs IRL CPI 2.5% 2.3% Ger IFO Fri UK GDP -0.2% -0.2% UK Index of Services 0.6% 0.0% US New Home Sales 307k 315k US Consumer Confidence Sterling finished stronger against the US dollar and the euro on the week after initially weakening against the former. The euro also lost ground against the dollar on speculation that a number of EU governments had lost patience with Greece and were prepared to accept a default rather than pump in fresh funds but recovered on news that an agreement was likely early in the coming week. The decline in euro GDP in the fourth quarter was also slightly less than expected, with French GDP showing a surprise 0.2% increase. The ZEW survey of German investor confidence was also much stronger than expected. The US data also generally came in on the stronger side of the consensus. Housing starts rose sharply and the trend now seems clearly upward, while another fall in jobless claims took the trend there to its lowest since early Manufacturing output also rose in January after a very strong December reading. The Fed remains cautious, however, as revealed in the FOMC minutes of the January meeting, with scepticism about the durability of the improvement in the labour market a notable feature. In Ireland, shorter dated bonds continued to outperform, with the yield on the 2014 s declining to around 4%. Data released by the Central bank showed a further deterioration in credit quality in the mortgage market, with the number of mortgages in arrears rising to 9.2% of the total in the fourth quarter of 2011, from 8.1% in q3 and 5.7% a year earlier. The Irish trade data for December showed a sharp fall in exports on a seasonally adjusted basis from an elevated reading in November, and a pick up in imports, so reducing the trade surplus to 3.5bn from 4.5bn. The surplus for 2011 as a whole was an estimated 44.6bn from 43.4bn the previous year and as such a record high. Dan McLaughlin Spot rates EUR/GBP EUR/CHF EUR/USD EUR/JPY GBP/USD EUR/CAD EUR/SEK EUR/PLN EUR/NOK EUR/ZAR EUR/HUF EUR/CZK Interest rate swap rates 2 year 3 year 5 year 7 year 10 year 15 year 20 year EUR GBP USD Official rates Current Q1 12 Q2 12 Q3 12 Fcst Cons Fcst Cons Fcst Cons EUR GBP USD Recent research See all recent research ( See most recent versions of: The Bulletin (monthly analysis of international and Irish markets) UK View (quarterly analysis of trends in the UK economy) The Outlook (quarterly analysis of trends in the Irish economy) Irish Property Review (quarterly analysis of Irish property trends) Irish Business Review (quarterly research, analysis and commentary) All rates quoted are indicative market rates

2 Data section contents Data section showing % changes on the week Long term fixed rates Commodity prices Europe Euro area economy contracted in Q4 Having slowed in the middle part of 2011, the euro area economy contracted in the final three months of the year with real GDP falling by 0.3% from the previous quarter, only slightly less than the 0.4% decline the market expected. Amongst the individual countries, the Italian economy shrank by a hefty 0.7% while the German economy contracted by 0.2%, though the French economy, surprisingly, expanded by 0.2%. A detailed breakdown of GDP at the Euro area level is not yet available, though separate data shows that industrial output in the zone fell by 1.7% in Q4, which would seem to account for most of the fall in GDP in the quarter. Moreover, the level of industrial output in December was 0.7% below the average for Q4 as a whole, which means there is quite a bit of ground to make up if output is going to post any increase in Q1. Still, though, the available survey data do suggest that industrial output, and GDP, will at least stabilise in the opening months of 2012 (as noted by ECB President, Mario Draghi, at last week s policy meeting). A return to growth generally would, of course, be facilitated by some resolution of the Euro area debt crisis. In fairness, the ECB s recent actions have helped to ease tensions, as reflected in the fall in Italian bond yields since December. The Greek saga continues to drag on, though its effect on markets recently has, in the scheme of things, been relatively modest. It now seems, though, that an end-game of sorts is in sight, with the possibility that Euro area finance ministers will sign off on a second bailout for the country this coming Monday. Hopes that a deal could be reached helped lift the euro off its intra-week lows of sub 1.30 to the dollar, with the single currency ending the week not far from where it started at almost $1.32. Ireland Mortgage arrears still rising Mortgage data published by the central bank showed the mortgages in arrears continue to rise. The number of residential mortgages which are in arrears (defined as 90 days or more) or have been restructured due to financial distress rose 8.4% in Q4. Nearly 108,000 mortgages were in arrears or restructured at the end of last year representing 14% of total residential mortgages. 9.2% of mortgages are in arrears as of the end of December. The number of mortgages continues to decline with 769,000 now compared to nearly 795,000 in September 09 when the central bank first published this series of data. The amount outstanding on mortgages has also declined with 113.5bn in loans at the end of last year compared to 118.6bn in September 09. There has been a sharp deterioration in credit quality in Ireland due to the housing market collapse with little end in sight. The housing market remains very weak with little prospect of a recovery in prices in the short term. Home purchase stimulus measures announced by the Government in Budget 12 and new negative equity mortgage products might boost activity somewhat in 2012 but the consensus forecasts do not see any increase in prices until United Kingdom Asset purchase scheme to come to an end? The latest inflation report was released during the week to a muted response as the Bank of England had already increased the asset purchase scheme last week on foot of the weakening outlook. That decision to increase purchases to 325bn might be the end of quantitative easing. The inflation report central forecast has the Bank rate staying at 0.5% over the next two years or so and then rising to 0.75% in Q3 14, alongside holding the level of asset purchases at 325bn. This scenario leaves inflation just marginally below the 2% target at the end of that period. However, the report then says that while the risk is that inflation will stay below target for most of the time frame by the end of the three year period those risks are judged to be broadly balanced. This points to the Bank of England being satisfied with the level of QE as it now stands and will go on hold. The report does not put forward any strong argument for further QE and the economic outlook would have to turn down further before further QE is deemed necessary. That said, Governor King was keeping his options open and in the press conference after the publication of the report he said that if the MPC want to do more (QE), we certainly could do it. In previous MPC minutes, the committee noted the difficulty in buying significant amounts of gilts within a short time period in a relatively tight market. King, however, belayed those concerns saying that the MPC were not at any practical limit in their gilt purchases if more needed to be done as the size of the gilt market was increasing all the time. On the outlook for the economy, King said that The path of recovery is likely to be slow and uncertain, and for much of this year, there is likely to be a zigzag pattern of alternating positive and negative quarterly growth rates, 10-year gilts fell slightly after the report and yields rose by about 5bps on the week. United States 2 Bank of Ireland Global Markets

3 Data section contents Data section showing % changes on the week Long term fixed rates Commodity prices Economic activity strengthening The latest data continues to point to strengthening economic activity in the US. Manufacturing output rose by 0.7% in January to leave the three month-on-three month increase at 1.6%, the strongest pace of growth in almost a year. Moreover, the survey data for February suggest further gains ahead. Retail sales rose by 0.4% in January having been flat in December, while core retail sales (excluding autos and gasoline sales) increased by 0.6% having falling by 0.2% in December. This would seem to leave overall consumer spending on course to at least increase at a broadly similar rate as in Q4. Even the housing market is showing some stirrings of life, with new housing starts increasing by 12% over the three months to January. The labour market, in particular, has outperformed of late relative to expectations and the trend of upside surprises continued with this week s data on new jobless claims, which fell to just 348k in the week ending February 11th, a four year low. The four-week moving average of jobless claims is now down to 365k, which is below the long term average of 375k (since 1990). The January payrolls report showed a gain in employment of 243k, and the trend in the jobless claims suggest we should now see sustained growth in employment averaging around 250k a month. The recent pick up in employment has contributed to a fall in the unemployment rate, which now stands at 8.3%. This is about where the Fed expects it to be at the end of 2012, according to its latest forecasts, so obviously there is a chance that the Fed s forecast will prove too pessimistic. The unemployment rate, though, is still well above what the Fed considers to be normal, which is 6% or less. The Fed also believes it will take some time to get back to there, which is partly why it has said exceptionally low interest rates are likely to be warranted until at least late The minutes of its January meeting, though, suggests the bar for further QE might have been raised somewhat. Only a few members now believe current economic conditions could warrant further QE before long, while others said additional QE could become necessary only if the economy lost momentum (as noted above though, the economy currently appears to be gaining momentum). Japan Bank of Japan adopt inflation target The Bank of Japan unexpectedly added Y10trn to their asset purchase program taking their total lending and credit stimulus programs to Y65trn ($830bn). The Bank also set a formal inflation target of 1% for the time being in another unexpected move. Many commentators suggested that the Bank was caving into political pressure from the Government who want the central bank to be more active in stimulating an economy which contracted by 0.6% in Q4 as well as to tackle the high value of the Yen. Governor Shirakawa denied that political pressure was behind the move and said the BoJ was just clarifying its position and its price framework was similar to the Federal Reserve which also recently set a formal inflation target of 2%. He also denied that their asset purchase scheme was now to fund a portion of Government spending. The statement said the Bank previously stated price stability to be gains between 0% and 2%, centred on 1% but had decided to set a goal of 1% for the time being to clarity the inflation rate which the bank aims to achieve. This inflation target could be very difficult to achieve in an economy where core inflation has not been above 1% since Governor Shirakawa said that Japan had a long way to go to beat deflation and that an inflation target was a better policy tool for Japan than a commitment to low rates within a timeframe. He repeated that the Bank did not have a magic wand to stimulate growth and that lack of demand was at the root of problem. The bank s announcement had an immediate positive effect with Yen weakening to over Y79 to the dollar from around Y77.50 at the end of last week. 3 Bank of Ireland Global Markets

4 Data section changes on the week EUR/GBP Spot % 1M 2 3M 9 6M 21 12M 55 EUR/USD Spot % 1M 1 3M 5 6M 13 12M 36 GBP/USD on the week Spot % 1M -4 3M -12 6M M -60 EUR currency pairs EUR/CAD % EUR/AUD % EUR/NZD % EUR/CHF % EUR/JPY % EUR/SEK % EUR/NOK % EUR/HUF % EUR/PLN % EUR/ZAR % EUR/CZK % USD currency pairs USD/CAD % USD/AUD % USD/NZD % USD/CHF % USD/JPY % USD/CNY % USD/MXN % USD/SGD % USD/BRL % USD/THB % USD/ZAR % GBP currency pairs on the week GBP/CAD % GBP/AUD % GBP/NZD % GBP/CHF % GBP/JPY % GBP/SGD % GBP/MYR % GBP/NOK % GBP/HKD % GBP/SEK % GBP/DKK % GBP/ZAR % on the Week Base O'night 1 week 2 week 1 M 2 M 3 M 6 M 9 M 12 M EUR GBP USD Interest rate swap rates on the Week 2 year Chng 5 year Chng 7 year Chng 10 year Chng EUR GBP USD Government bond yields (YTM) on the Week 2 year Chng 5 year Chng 10 year Chng 30 year Chng Ireland Germany US UK Prime Rate Bank of Ireland prime rate 1.25 on the Week ISEQ % DOW Jones % S&P % SMI % Nasdaq % FTSE % Eurostoxx % Nikkei % Commodities on the Week Brent % WTI Cushing % Gold % Wheat % Emissions Allowance % 4 Bank of Ireland Global Markets

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