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Capital Markets

Market prospects: S&P changes mind on prices

After earlier forecasting that European share prices would rise in 2006, Standard & Poor’s equity research now expects a 7% fall. The change in outlook is the result of the European Central Bank’s decision to jump on the bandwagon of global monetary policy tightening.

The ECB’s decision to raise rates in December by 0.25 percentage points, the first increase in five years, is expected to be followed by Japan, where investors expect the central bank to begin raising rates in 2006.

“We believe that investors are too sanguine about the impact of higher interest rates on equity markets in 2006 – 2005/06 is the first time since 1986 that investors have faced a coordinated global tightening of monetary policy,” says Clive McDonnell, European strategist at S&P.

S&P expects that further rate rises by the ECB will have a particularly adverse effect on eurozone banks, which benefited from double-digit growth in mortgage lending over 2004/05.

Rising benchmark bond yields and a flatter yield curve are also expected to hit fixed income sales and trading profits at the big German and Swiss investment banks. For 2005, fixed income sales and trading revenues are expected to account for as much as 30% of net income at Deutsche Bank and 20% at UBS.

Utilities are also expected to suffer as a result of rising interest rates as their performance is strongly correlated with rising bond yields. The sector could also be hit by a modest drop in oil prices in 2006.

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