In the six months to come, the European Central Bank, the Federal Reserve and Bank of England are unlikely to change their benchmark rate. This is the view held by the overwhelming majority of our 12 surveyed economists. Only three economists expect the ECB to lower its benchmark rate below the current 1%, following a monetary course embarked on since early October when the benchmark rate stood at 3%. JP Morgan forecasts a 50bp drop by the end of August while HSBC awaits a 25bp reduction in the coming three months as does BNP Paribas.

“The most likely scenario is that the Governing Council will leave key interest rates unchanged at it next meeting June 4,” according to Clemente de Lucia, economist at BNP Paribas. “If the recession is deeper and longer than the Council forecasts, the ECB could take further action. In particular, a widening output gap and rising unemployment rate could put more downward pressure on prices. Mounting risks of deflation might induce the bank to cut the refi rate by a further 25bps.”

While our surveyed economists do not expect the benchmark rate to change any time soon, their forecast for longer-dated bonds and gilts continues to move higher. The yield curve, which has already steepened in recent months, could accordingly steepen further. The consensus view of our economists is for 10-year gilts to rise to 3.76% on average in six months. Last month, their expectations six-month out were considerably lower (3.18%). The same trend can be observed in the US and the euro zone, though the biggest jump in 10-year yield expectations remains in the UK (58bps), followed by the euro zone (39bps) and US (7bps). Current 10-year yields are still above our economists' revised projections.

On May 27, the spread between the benchmark US yield curve widened to 275bps, the widest it has been since 2003 and approaching a record spread. The benchmark yield curve measures the difference between the yield on the 10-year Treasury and the two-year note. “The global economy entered this year in dire straits and a debate raged about how long the downturn would last,” according to JP Morgan. “Less than six months later, it appears that the recession is about to end. This view is not yet validated in broad activity, however, evidence pieced together from surveys, demand indicators that highlight behavioural change and activity readings in key pockets of the globe that provide reliable early signs are now altering views about where we are headed.” One leading index constructed by Columbia University’s Economic Cycle Research Institute shows a reversal. Its US Weekly Leading Index has stabilised at 111.1 from 132.9 a year ago.

A steep yield curve typically precedes an economic recovery. It may also be a response to the increasing supply of government debt. The government has tried to dampen such concerns by creating demand for its own debt via a program to buy up to $300bn in Treasuries. This has not had the intended effect on longer-dated Treasuries even as short-term rates have dropped sharply. Since the re-purchase program was announced in March, yields on 10-year Treasuries have risen. At the end of April, they were above 3%. Considering $100bn was used to buy Treasuries last week (with little impact on longer-term yields), the Federal Reserve may have to broaden its repurchase program. Finally, on the forex front, our economists expect the euro/dollar rate at 1.35 on average in 2009 compared to 1.34 from last month.

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Consensus June