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Central European Daily

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Risk of coalition brake−up weakens the HUF

Mon, Mar 31 2008, 09:25 GMT
by KBC Market Research Desk

KBC Bank

Headlines

• Currencies: Risk of coalition brake-up weakens the HUF
  
• Fixed Income: Hungarian NBH expected to hike up to 7.75%

Currencies

The Hungarian forint has weakened 1% on Friday and this trend could continue amid rising political tension after the Prime Minister sacked the health care minister. The junior coalition party Free Democrats criticized the Prime Minister for not talking with them before the decision. On the other hand, the major coalition partner Socialists want to redraft the law that would allow private investors to take part in the health insurance system. The Prime Minister is also the leader of the Socialist party and therefore he is advocating the view of the party, but his room to maneuver is very limited.

Possibilities range from early elections (the main opposition party leader Mr Orban projected this over the weekend) to replacement of the Prime Minister and a minority government. When the Prime Minister was replaced in 2004, the HUF weakened 2% and recovered later, after the new Prime Minister was inaugurated.

The current situation is complicated by the weak international background, while today’s central bank decision could start the monetary tightening cycle, which could lend some support to the currency. The straight question here is whether they will do 25bps or 50bps, but more important could be how markets will interpret their general stance. If they see the central bank to fall behind the curve, local markets could remain sensitive towards weakening, while a more pronounced hawkish rhetoric could help ease the tensions, although it looks unlikely that central bank has any option to stabilize markets in the current political environment.
A quick resolution to this political problem looks unlikely and thus we expect the political debate to weigh on markets for some weeks. This may allow the currency to weaken back to the 260-265/€ territory.

The Polish zloty traded within an extremely tight range between EUR/PLN 3.52 and 3.53 only to end the day slightly higher against the euro. The pair was reluctant to react to the third consecutive fallback in core equities, largely we think due to rate hike expectations reinstalled by several rate setters earlier in the week, but in the end we doubt whether the zloty will be able to resist further downward pressure in the ST if stocks attempt to retest recent lows. On the other hand, a positive turnaround in equities could no doubt change the sentiment further in favour of the PLN.
Even though the fundamentals remain broadly favorable in the medium and longer run, we are looking for the market to enter calmer waters ahead of tomorrow’s CPI estimate by the FinMin and the US payrolls further out into the week.

The Czech currency tried to extend its previous gains but the EUR/CZK failed to break below the 25.22 resistance. Hence, lacking strong stimuli the pair closed the week around the 25.3 level.
This week will be very poor from a domestic data perspective, but the international eco calendar is very busy. The attention in all markets will go out to the early month data (ISM/Payrolls) in the US and a key speech of Mr. Bernanke on the economy. The Czech currency might again be influenced by global equity markets, while ongoing speculations around possible utilization of privatization proceeds (denominated in EUR) might also grab some attention.

The Slovak koruna had the tendency to depreciate early in the morning on Friday. But it corrected before the noon. There is still some nervousness around the chances of Slovakia for the euro adoption in January 2009. Governor Sramko tried to calm down the markets and said that the sources speculating about the red light for Slovakia are not well informed. The eco calendar is very light this week and external factors should dominate the market. We think that any spike too far from 32.50 should still be followed by a quick correction to this crucial threshold (market consensus for the conversion rate).

Fixed income

The Hungarian bonds reversed their two-week appreciating trend and Friday saw yields rising again, which will likely continue on the back of the political situation. Bonds are usually closely correlated to the currency, when markets are volatile, hence yields could follow the currency in coming days.

Polish bond yields inched mildly higher across the curve (by 2-3 bps) after rate setter Marian Noga indicated that rates might rise again in April, only to stage a full zlotyled comeback for longer maturities later in the session.
The only relevant item on the local calendar this week is the FinMin’s March CPI estimate due out tomorrow. A reading above 4.2% y/y, which is our preliminary estimate, would most likely lead to a deeper inversion of the curve while an unexpected drop to or below 4.0% could lead to a profit taking on shorts in the 1-2Y segment. For today we keep to our ST neutral stance - the market should enter calmer waters as investors gear up for tomorrow’s release and the barrage of US data later in the week.

The Czech yield curve steepened on Friday, as yields went higher especially on the long end of the curve. That might be due to the strong koruna and stable domestic rates.

At the beginning of the week, Czech bonds may still feel the pressure from the higher euro zone inflation figures. Nevertheless later during the week the attention should refocus on the crucial US figures on the long end of the curve and the Czech koruna on the short end.

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Published on  Mon, Mar 31 2008, 09:42 GMT