Big Picture: Last week’s data was mixed, but we stick to our above consensus view of the economic outlook. As always, risks and uncertainties remain. It has been surprisingly quiet on the US budget and debt ceiling front. A repeat of the deadlock experienced a couple of weeks ago remains a possibility. In addition, concern over US Federal Reserve tapering is always close to the surface. In Europe, preparations for the Asset Quality Review are is in full swing. It will be months before we will see any results, but this review clearly has the potential to produce unpleasant surprises. On balance, however, we think that the risks will not disrupt our main scenario.
Interest rates: The rise in eurozone inflation in November reduces the chances of major action at this week’s ECB meeting, though inflation is still too low and we expect a clear message that policy will remain accommodative for a prolonged period. In addition, we think further ECB action in coming months remains a possibility. Meanwhile, S&P downgraded the Netherlands’ sovereign credit rating to AA+ from AAA, with a stable outlook. Although, there is clearly a risk that other agencies will follow, it does not seem obvious on the basis of the triggers they have cited and the recent moderate improvement in prospects.
FX: A big theme in currency markets recently has been the weakness of the Japanese yen across the board. The yen has been undermined by expectations of more monetary easing by the BoJ and the re-instating of carry trades. Last week, the euro was pushed up by the higher than expected inflation data. Nevertheless, we expect dovish ECB commentary and subdued inflation forecasts at this week’s meeting to undermine the euro. Meanwhile, we expect the US dollar to receive support from stronger US economic data.