The ECB Walks The Talk, And Cuts The Refinancing Rate

Review
In the past month, rates have continued lower and yield curves have steepened further in Europe and the US, driven by dovish central banks, mixed data, and declining inflation.

The ECB in particular has stepped up its actions by cutting the refi rate to a historical low of 0.25% following the surprisingly low inflation print in October. Moreover, comments from senior ECB officials suggest that the tool box is not exhausted

International rates

We expect the ECB to deploy further easing measures in early 2014 to accommodate the disinflationary outlook. While the hurdle for doing outright quantitative easing (QE) is probably high, another 3-year LTRO seems more likely.

Another LTRO is unlikely to push money market fixings much lower, but it would ensure a cap on short-dated EUR rates. During the coming year, longer tenor EUR rates are forecast to move higher along with increasing USD rates as tapering draws closer.

In the November Inflation Report the Bank of England moved its forecast for the unemployment threshold to be met from Q3 16 to Q3 15. This is much more aligned with market expectations as the market currently prices the first rate hike in the summer of 2015.

Scandi rates

We expect Danmarks Nationalbank (DN) to deliver only one rate hike of 10bp over the coming 12 months. If the ECB introduces another LTRO we do not expect DN to follow, as DN has stated that there is enough liquidity in the Danish system.

In our view, the preconditions for the Riksbank attaining the 2% inflation target are worse than ever. An increasing pressure to cut the repo rate is likely and we expect a 25bp cut at the December meeting.

We currently view the Norwegian money market as too soft with regard to the likely next message from Norges Bank, which we think will postpone the first rate hike only moderately. We still look for a rate hike on a 12M horizon.

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