The Baltic states, in particular Latvia and Estonia, offer an interesting if extreme template for the resolution of imbalances elsewhere in Europe, but with a few notable differences. Imbalances have been unusually large, the correction started early, is already severe in terms of growth and asset prices, and will be prolonged. On the other hand, their small size, the small number of otherwise healthy banks involved, extreme labor mobility and very limited financial markets offer some protection. While the correction is so far slightly quicker than we had expected, we still expect all three to tolerate significant pain in pursuit of euro membership, and to resist devaluation.
[I]Stephen Roach, Head Economist, Morgan Stanley[/I]
[B]Weekly Bank Research Center 06-16-08[/B]
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[B][B][B][B][B] The Euro at the End of the Tunnel [/B][/B][/B][/B][/B]
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[I] Stephen Roach, Head Economist, Morgan Stanley [/I]
The Baltic states, in particular Latvia and Estonia, offer an interesting if extreme template for the resolution of imbalances elsewhere in Europe, but with a few notable differences. Imbalances have been unusually large, the correction started early, is already severe in terms of growth and asset prices, and will be prolonged. On the other hand, their small size, the small number of otherwise healthy banks involved, extreme labor mobility and very limited financial markets offer some protection. While the correction is so far slightly quicker than we had expected, we still expect all three to tolerate significant pain in pursuit of euro membership, and to resist devaluation.
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[B] An Era Gone By… [/B]
[/B] [/B] [/B] <em> Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
What a week. What a month, a year and perhaps an era. The past week has seen dramatic movements in many markets, not least in rate markets. US 2-year swap rates have risen by 68bp, the largest 5-day gain since March 1985. The main shock to financial markets is coming from rising inflation, actual as well as expected. We have long operated within a strategic framework of a dual shock from a financial crisis combined with a cyclical downturn. As central banks and investors react to higher inflation, inflation must increasingly be viewed as a theme of its own. In brief, rising inflation is not good news. Higher inflation caused by rising energy and food prices translates directly into lower consumer income. Monetary tightening, as indicated by both the Fed and the ECB, together with delayed rate cuts - like in the UK and Canada - or outright interest rate increases - like in Denmark, South Africa and a number of Asian countries recently - also put a damper on the economy. Combined with the ongoing financial crisis, which tends to make banks less willing to lend money, and a turnaround on several housing markets, this point toward a deeper and longer cyclical downturn. We have previously warned against excessive optimism in 2008 and are becoming increasingly concerned about the outlook for 2009. Cyclical downturns are normally negative for UAD, GBP and CAD and positive for EUR, CHF and JPY.
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[B] Long-Term Interest Rates On the Rise [/B]
[/B] [/B] [/B] [I] E. Silvia, Ph.D. Chief Economist, Wachovia[/I]
Long-term interest rates in most major economies have moved up sharply in the last week or two as central bankers have turned hawkish. The surge in energy and food prices has had only limited effects on core rates of inflation so far. However, central bankers appear determined to avoid a replay of the 1970's when sharp increases in energy prices led to generalized acceleration in most other consumer prices. Credit market dislocations and forecasts of slower growth had led investors to anticipate ECB easing by the end of the year. However, the ECB has refrained from cutting rates, and it now looks like it will raise rates by the end of the year to keep inflation expectations contained. Although the Bank of England will probably cut rates again before the end of the year, the recent rise in CPI inflation makes a significant amount of easing less likely. Changes in our interest rate outlook have some implications for our exchange rate forecasts. We had projected the dollar would begin to strengthen versus the euro in the third quarter of this year as investors began to anticipate Fed rate hikes. With rates heading higher in the Euro-zone and not rising as fast in the United States as we had originally projected, the dollar will likely continue to struggle versus the euro in the near term. Although the euro could easily test its all-time highs, we do not believe a sharp decline in the dollar is likely. U.S. officials have recently hinted at the possibility of foreign exchange market intervention, which would give the greenback some support if it came under selling pressure.
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[B][B][B][B][B] Bank of Canada Shocks the Market With a Pause [/B][/B][/B][/B][/B]
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[I]Steve Chan, Economist, TD Bank Financial Group [/I]
While the Bank of Canada’s interest rate decision stole the spotlight in Canada last week, there were some key economic data releases that warrant some attention. On the brighter side, housing starts rose back above 220,000 in May, suggesting that the housing sector is likely to hold up relatively well this year, although activity will be below the rapid pace seen in 2005-07. The manufacturing sector has also shown some resilience, with industries representing 80% of total sales posting gains in April. But while three of the first four months of this year have seen growth in the volume of manufacturing sales, the sector is unlikely to contribute much to overall growth in the coming months, if at all. On the downside, international trade data revealed the Canadian trade surplus narrowed in April, as export volumes (-1.7%) declined for the second consecutive month. This is a trend that is likely to continue as U.S. demand for Canadian goods softens along with the economy, and the elevated loonie provides ongoing support for imports.
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[B][B][B][B][B] Will the BoE Governor Have to Write an Open Letter? [/B][/B][/B][/B][/B]
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[I]Trevor Williams, Chief Economist at Lloyds TSB Financial Markets [/I]
One of the key questions this week is whether the Governor of the Bank of England will have to write an open letter to the Chancellor explaining why inflation is more than 1% above the 2% target and what he is doing about it. Our forecast shows consumer price inflation hitting 3.3% in May, the highest rate since the measure became the target in 2003 and the highest since July 1992. Other UK data will suggest that the economy, though slowing, has not ground to a halt, with retail sales up 4% in the year to May – based on a fall of 0.2% in the month. Monetary policy meeting minutes, due Wednesday, will suggest whether official interest rates are on prolonged hold, as we suspect, rather than rising, as markets expect. In the US, after some poor inflation data, attention switches to the housing market, producer prices and production. A modest US growth outcome looks likely in Q2. For the Euro area, the data releases this week will focus on consumer prices, with a record high expected. High commodity prices have contributed to a sharp rise in inflation expectations everywhere.
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[B][B][B][B][B] Other Pre-screened Independent Contributors[/B][/B][/B][/B][/B]
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[I] J-Chart [/I]
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