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Central European Daily

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CNB expected to cut interest rates by 25 bps

Thu, Nov 6 2008, 08:41 GMT
by KBC Market Research Desk

KBC Bank

Headlines

Currencies: CEE currencies weaker as post-election rally has faded out
Fixed Income: CNB expected to cut interest rates by 25 bps

Currencies

Calmer trading conditions have been the major highlight of this week’s trading. While the key market moving events are still ahead of us (ECB, payrolls) we believe that given the slightly stronger liquidity conditions the EUR/PLN 3.50 – 3.60 range is likely to remain in place for now. This said, the soft overnight performance of Asian equities suggests that the upper bound of the range might be tested today. An aggressive cut by the ECB would in principle be positive for the PLN due to the rising interest rate spread. However, if at the same time the euro weakens significantly against the dollar, this would be a strong negative factor for the zloty as fight to US assets has tended to weigh heavily on the region. This said we think the reaction of the PLN to a dovish ECB would be neutral or, even slightly negative in the short term.

The Hungarian forint had a relatively quiet session despite the sentiment turning sour on equity markets and OTP coming under renewed pressure and losing 6% on the day. The currency’s resilience suggests that market positioning has been light after foreign investors sold roughly €3bn during the recent turmoil and double digit interest rates have been supporting the forint.

Today’s ECB decision could play an important role as lower core market rates would increase the risk premia offered by the forint. Decreasing volatility may also make the wide interest rate differential more attractive, a process that has been witnessed after the meltdowns in 2003 or 2006 and could be repeated again now. Shrinking volatility could thus be the next step in the recovery process albeit market is still facing the risk of a deeper recession and more losses at banks. The steep fall of export in August is a clear sign of this, although the trade balance actually improved as import fell more than export.Details about the IMF package could be announced today.

The optimism on the Czech FX market has vanished as fast as the post-election rally on the Wall Street. Hence the koruna weakened during most of the session and the pair moved as high as 24.50 EUR/CZK.

Today the most important event for the koruna is the CNB and ECB meetings. Both central banks are expected to cut, although the CNB by only 25 bps compared to the 50 bps cut expected in the eurozone. Nevertheless both actions should be rather negative for the Czech currency as these are expected to trigger further outflow from the region to the US dollars.

The Slovak koruna was locked in the range of EUR/SKK 30.30 – 30.40. The only interesting news came from the macro front where retail sales slowed down its dynamics to 4.6% in September Y/Y from 5.8% Y/Y in August. The market expected a 6.4% Y/Y rise. This is a clear sign that domestic demand is slowing. The eco calendar is empty today and we are curious how the industrial production will have done in September (scheduled for Friday).

Fixed income

Polish bond yields headed further south on Wednesday as liquidity conditions continued to improve. Interestingly the move was strong also at the long end of the curve despite the stable, or even slightly weaker, zloty. This only goes to show the rise in yields seen in mid October was highly exacerbated by the appallingly low liquidity. Given our expectations for a slightly weaker currency in the hours to come we would bet on some profit taking for longer maturities and a steepening of the curve. The market will look with attention to the ECB and BoE rate decisions later today.

The Hungarian bond recovered some 30-50bps as some demand from foreigners returned to the market. This meant that yields above 13% are not seen anymore and even 12% levels are difficult to find. The curve has a hump at the 3-5 years part as banks are more active at shorter maturities due to funding duration and asset managers are buying more of the longer-dated papers, leaving the mid-part less affected. This could also mean that this is the area with the biggest recovery potential, although surely this looks to be a high risk/high return game now.

Czech bonds firmed yesterday with trading volumes above the average. Yields fell by 6-8 basis points at the middle and the long segment of the yield curve while the move at the short end was even more pronounced. The reason behind this development was mainly declining stocks at domestic as well as global stock markets.
Today three central banks’ meetings are scheduled – ECB, BoE and CNB. We believe that Czech central bank unlikely the ECB and BoE will cut rates by only 25 basis points. Nevertheless rate cuts are already anticipated, thus their market impact will be limited. In spite of that, we expect the short end of the yield curve to move further downwards. The development of the long end of the yield curve will be dependent on stock markets again.

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Published on  Thu, Nov 6 2008, 08:58 GMT