Rate & Forex Consensus - January 2012

Will there be an end to tension on the interbank market in 2012? Last year, the 3 month Euribor was up by 39% rising from 0.98% to 1.36% between the beginning of January and the end of December. This increase would have undoubtedly been greater without the repeated interventions of the European Central Bank, whose three year refinancing operations (LTRO) pushed interbank rates down from the beginning of December. The distribution of a record amount of liquidity to European banks on the occasion of the refinancing operation of the 22 December (€495 billion at a rate of 1%) fuelled the downward movement of interbank rates, even if a major share of the liquidity supplied by the ECB was immediately replaced at the central bank through its deposit facility (which only remunerates cash at 0.25%). "The ECB's initiative is clearly aimed at relaxing monetary and financial terms, which had tightened considerably in the past few months," notes Clemente De Lucia, an economist at BNP Paribas. "Following the latest refinancing operations, domestic liquidity strongly increased. This should help to pacify monetary markets and relax the rates. On a day-to-day basis, the Eonia should evolve towards the interest rate on the deposit facility," he points out.

Besides an extension of the average maturity of the liquidities registered in their balance sheets, European banks benefited from the ECB long term refinancing operation to secure the bulk of their financing needs in 2012. A second operation of the same kind is scheduled for 28 February. So, when faced with the inflow of ECB liquidity, recourse to the interbank market seems bound to be diminishsed. The members of the bfinance Interest & Foreign Exchange Rate panel anticipate a significant easing of the 3-month Euribor in 2012, at 0.73% on average over the year, i.e. a drop of 60bps compared to its level of 3 January. The panel also anticipates a further 25bp fall in rates before the end of March. 

A number of observers see LTRO as a means for the ECB to get round the ban on intervening directly in the primary sovereign debt market . In the Financial Times, Mario Draghi stated: "the banks would independently decide how they intend using [ECB liquidity]", while mentioning that the acquisition of sovereign debt is one of the possibilities. This assumption flies in the face of the behaviour displayed by some major European banks last year (BNP Paribas, Commerzbank, HSBC) which, according to figures by the European Banking Authority (EBA), lessened their net exposure to the debt of countries in the euro zone. "The main question is whether the markets will be willing to absorb new issues of sovereign debt, in particular in the first quarter when the Italian treasury is due to issue approximately 40% of its annual needs," says Sylvain Broyer, economist at Natixis. When the European stability mechanism comes into force, Natixis is expecting tensions around the sovereign issue of liabilities to be eased starting in July. The Italian issue of 29 December, which ended in a €7 billion investment over 10 years at a rate of 6.98% (as opposed to a rate of 7.56% for the previous issue of 29 November), allowed investors' appetite to be tested before the significant due dates at the beginning of the year.

According to Natixis, the fall in target rates and the increase in liquidity "should reduce the external value of the Euro". For the seventh month in a row, the panel revised its forecast value of the single currency downwards not only against the dollar, but also against the pound and the yen. By the end of March, the Euro is now expected to come in at 1.30 dollars, 0.85 pence and 98 yen, levels very similar to those observed on 3 January (1.31 dollars, 0.83 pence and 99 yen)

At the same time, Natixis is anticipating slow growth across euro zone countries in 2012 (0.3%), only Germany (0.9%) once again still managing to stand out among the major countries. German rates at 2, 5 and 10 years are expected to reach 0.41%, 1.07%, and 2.04% at the end of the first quarter, up by 22bps, 26bps and 14bps respectively, compared with levels observed on 3 January (0.19%, 0.81% and 1.90% respectively). This upward trend of German rates is also expected to continue during the second quarter.

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