Tuesday, November 23, 2010

European short-term interest rates and bond yields – Eurozone: One monetary union, very different economies

Owing to fiscal tightening in the eurozone we expect decelerating economic growth for the time being. The – temporary – bail-out of Ireland does not change a thing. Both Ireland and the eurozone are still facing the same problems. As the situation in the weak euro countries is quite desperate, long-term interest rates in these member states will likely continue to rise. Simultaneously, the spread between bond yields in the weak and the strong euro states could widen in the coming months. On top of this, the 3-month EURIBOR may be expected to rise in the coming period, whereas the EUR swap spread could continue to widen. The main reasons are slowing economic growth, mounting uncertainty on the financial markets, and fresh banking woes. The 3-month EURIBOR may climb from around 1.04% towards 1.50% as the EUR swap spread widens from near 30 bp to around 50 bp. In the coming months the German 10-year yield (now around 2.7%) could on balance rise towards 3% in the wake of rising US bond yields. Subsequently, it may fall quite sharply.

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