The Czech koruna under modest pressure, but more might come

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Currencies: The Czech koruna under modest pressure, but more might come
Fixed Income: CNB shocks the market and slashes rates by 75bps

Currencies

The Czech koruna was under moderate pressure ahead of the CNB meeting. The immediate reaction to the surprisingly aggressive 75 bps rate cut was like an example taken from a textbook - the EUR/CZK currency jumped higher towards 25.0 EUR/CZK.

In view of the aggressive moves by the Czech National Bank, the Czech koruna should remain under increased pressure until the end of the year. In addition to the uncertainty about the impact of the global crisis on the Czech economy, the interest rate differential now develops in an unfavourable way for the koruna. This should encourage the remaining short-term investors to leave the country, or it may even motivate foreign speculators to open short positions. Hence we do not rule out that the koruna may again exceed 26.00 EUR/CZK within the forthcoming month.
Nonetheless, the Czech currency should re-win foreign investors’ favour during the first half of 2009, as we believe the Czech economy should show its relative resistance to the ongoing economic crisis (3% growth as opposed to the Eurozone’s stagnation) and as the CNB, with its current speed of rate cuts, may be ahead of the ECB.

The zloty fell victim to renewed risk aversion on Thursday as central banks intervened to support faltering growth. The EUR/PLN inched above 3.60 at the end of the day, breaking above the upper bound of the recent technical range. Although we hold on to our EUR/PLN 3.50 medium term target for the zloty, as long as the flight to security continues the PLN is likely to remain under pressure. We would treat further weakness (above EUR/PLN 3.70 ) as a zloty buying opportunity, but would have to see visible signs of improving global risk appetite before turning positive on the PLN in the short term.

The Hungarian forint followed other emerging market currencies’ weakening and the pair rose to 262-263. Markets have became concerned about a deeper global slowdown after the IMF report and central banks rate cuts as it will have a negative effect on export driven economies.
Hungary’s letter of intent to the IMF was also published yesterday. It mainly repeated the early announced additional fiscal tightening for 2009, but added some more details about a strong monitoring by the IMF of the development in the next quarters, including the quarterly monitoring of the primary balance and public debt with reference to the quantitative targets. It also promised the introduction of a medium-term fiscal rule on the primary balance and debt that could reduce the risk of fiscal loosening in 2010-2011.

The Slovak koruna was again in a tight range of EUR/SKK 30.30 – 30.45. The local economic calendar consists of figures from the industry and construction sector. It is widely expected that industry is slowing down and the headline figure should be close to 1 percent growth.

Fixed income

Polish bonds have been less affected by the most recent sell-off so far, as limited liquidity returned over the last two weeks and rate cut expectations were gradually priced into the market. The Polish MPC is unlikely to start cutting rates before Q1 2009 (the need to keep rates flat for a while has been voiced by hawkish members of the Council, but also some of the doves have voiced similar views since the last policy meeting). Nevertheless, deeper than previously expected cuts next year seem inevitable, as the ECB goes to 2.0% or below with its easing cycle. This would of course support the economy but would also help fend off speculative capital ahead of ERM-2 entry. In the very short run, the weakening zloty puts the long end of the curve at risk. We prefer a buy on dips approach and look for a steeper curve in the medium term.

Hungarian bonds tracked the currency as usual these days and yields increased by some 20-40bps across the curve. Turnover however has been reviving, which is also an opportunity to foreign investors to reduce positions as is suggested by the drop of total non-resident bond holdings of government securities to Ft2700bn from Ft3300bn.

What a big surprise from the Czech central bank yesterday! The CNB was widely expected to cut rates at its bank board meeting but the board surprised the market by slashing rates by 75bps. In one minute one could speculate that the fact that the BoE surprisingly cut by 150 bps motivated the CNB for coordinated action, but it was not actually true as CNB governor Tuma indicated at its press conference.
First, the CNB’s surprisingly aggressive decision stemmed from a very favourable inflation outlook, which envisages an inflation fall to as low as 2.3% in the third quarter of next year and from a worsened outlook for economic growth, from 3.6% to 2.9%. Secondly, the CNB’s most rapid rate cut in more than six years was also motivated by bank’s aim to cut market rates. The rapid fall in the CNB’s base rate should help to normalise the situation in the Czech money market, where market rates have significantly diverged from CNB rates in recent days, while trading has been declining. The rate cut actually pushed market rates downwards, but money market rates still remain far above the CNB’s base rate. We think that the market is likely to return to its normal situation after a prolonged period, unless any depreciation of the Czech koruna complicates the situation. In fact, the central bank’s forecast of the three-month Pribor envisages 2.4% in the third quarter of 2009 (yesterday close was at 3.85%) and 3.2% in the first quarter of 2010. The forecast indicates that the CNB will continue to cut rates. Hence, within the months to come, we may see the central bank’s base rate go down to as low as 2.0%, i.e., the level of one and a half years ago

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