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Central European Daily

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Moderating inflation helps Czech bonds to recover

Mon, Jan 12 2009, 08:24 GMT
by KBC Market Research Desk

KBC Bank

Headlines

Currencies: Forint weakens below 280 EUR/HUF
Fixed Income: Moderating inflation helps Czech bonds to recover

Currencies

Unlike its regional peers the Polish zloty managed to work out modest gains on Friday, in somewhat calmer, but still illiquid market conditions. The payrolls report and the knee-jerk reaction from the dollar were both largely ignored. The 3.0 level should provide the USD/PLN with strong resistance, which is likely to help keep the EUR/PLN bound in the current 4.02-4.08 range in case the greenback extends its gains versus the euro. We think trading will remain sentiment driven in the days to come, despite the heavier data calendar. Domestic macro data will be far more interesting for bonds than for the zloty.

The Hungarian forint finished the week with a sharp loss of almost 3% as market participants got concerned about this year’s budget deficit target. Lower than planned inflation and a deeper recession could hurt revenues and that could require additional government steps to keep the budget deficit on track to meet the 2.6% of GDP deficit target. Overall, some Ft100bn to 200bn or 0.3 to 0.6% of GDP could be the shortfall on the income side, which looks significant, but not impossible to handle. For example, the government could decide on hiking the VAT rate on March 1 from 20% to 23%. The currency however might remain under pressure to weaken further in the coming weeks and it may also test last year’s high level of 286.20/€.

The Czech koruna showed a textbook reaction to the December CPI figures, which confirmed that further monetary easing, is on the table in the Czech Republic (see the fixed-income part). Moreover, overall sentiment on the regional forex markets remains poor as the performance of the Romanian currency weighs on the region.
Hence, the EUR/CZK is moving back north towards the 27 level. The next key event might be Thursday’s ECB decision, which might be another negative surprise for Eastern European currencies, as we expect a finely balanced decision to leave rates unchanged at 2.5% on Thursday.

Fixed income

The rally in Polish bonds continued on Friday with yields down by 5-10 bps across the curve in anticipation of weaker growth and (much) lower official interest rates. Gains in the Polish bond market have been profound over the last several weeks as extensive rate cut expectations were gradually priced in, and while we remain positive for short maturities, the risk is rising for some profit taking. We would treat this as an obvious buying opportunity. The weaker zloty could be the trigger, although if the currency keeps its composure, the bond market would remain in positive mode ahead of the CPI numbers due out on Wednesday and the barrage of data next week.

The Hungarian bond market followed the currency again as usual these days and yields rose another 20bps. The 10-year yield is now back to 9% and rising long-term yields could signal that the current exchange rate level could also affect the inflation outlook substantially. The Central Bank will not ignore further weakness on the market, but if the challenge is really on the budget side, tightening of monetary conditions may only give us short-term relief. Given the deteriorating inflation outlook, we may also hear some verbal comments from the monetary council members this week.

Czech bonds strengthened on Friday, partly due to the gains of the German bund and also thanks to decline in domestic inflation. Although the inflation figure came out as expected (3,6% Y/Y), it is far below the central bank’s forecast and shows there is room for further monetary policy easing. Today, there are no new figures scheduled for release. Nevertheless, fears about the conditions of the economy should keep the Czech bonds still attractive at current yields. On the other hand any gains may be capped by the losses of the Czech koruna.

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Published on  Mon, Jan 12 2009, 08:30 GMT