NBP rate decision in focus

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Currencies: The Czech government toppled in non-confidence vote
Fixed Income: NBP rate decision in focus

Czech Republic

The Czech koruna weakened to 27.20 EUR/CZK on the non-confidence vote for the Czech government. The Topolanek government was toppled yesterday in a noconfidence vote of 101-96 in Parliament. The 97 opposition MPs were joined in voting against the government by ex-Green and ex-ODS MPs. It is highly probable that President Klaus should authorize the current government to stay in place at least until the end of the Czech presidency. Hence at least until June there should be no dramatic shift in the Czech economic policy. Afterwards there are many alternatives of what can happen including several short term coalitions and early elections. We consider the most probable outcome to be the early elections as the regular elections term is approaching quite fast (scheduled for 2010). The highest risk for the Czech economy is the prolonged political instability that could bring pre-election populism and much higher public spending and deficit. If that does not materialize, we believe the current weakness of the Czech markets and the Czech koruna notably, should be short-lived and limited. Also from the historical point of view koruna proved to be quite resilient to the domestic political turmoil, unless it affected the public finance.

The Czech bonds strengthened on Tuesday and the yield curve dropped along the whole length and flattened, its yields lost up to 7.5 bps at the long end. The domestic bond market mirrored political development on the political scene as uncertainty about the future of the Czech government ahead of non-confidence vote together with lower retail sales supported bonds.

Today the main issue on the Czech bond market is the auction of 4.10%/2011 state bond in the volume of CZK 10 bln. As investors have a lot of European bonds available and also this year’s domestic deficit will require more bond issuance the Ministry of finance should accept higher yields. Indeed, the ministry’s ability to give higher yields is the main feature for auction access. As for the second bond market, a day ahead of CNB meeting, should keep investors to be careful. However, political influence after non-confidence Parliamentary vote remains a wild card during today’s trading.

Hungary

The Hungarian forint continued its slow recovering trend on Tuesday after the PM resignation over the weekend led to a weakening at the start of the week. Hungarian press are full of reports about the new PM. Daily Nepszabadsag cited three names of whom only Gyorgy Suranyi seems to be the most likely candidate. The others (Mr Glatz and Mr Vertes) do not have experience in finance, while Mr Suranyi was Governor twice, currently is the regional head of Intesa and took part in the Bokros- Suranyi stabilisation package in 1995. Because of his important role in the stabilisation, markets could welcome him and if MSzP wants to minimise the additional fiscal tightening, this could be the most important reason. Therefore, new government could keep tight fiscal policy to meet the below 3% deficit target of the IMF program and may also introduce some window dressing reforms, which are not too painful, but enough to cheer markets. If the global growth cycle bottoms out in the next 3-6 months, Hungary may also slowly recover later this year and new government could be praised for rescuing Hungary next spring.

In short, our base case scenario is that markets will welcome the new PM and there could be a nice rally in HUF, bonds over the next weeks/months. Downside risk is probably limited in the forint because the central bank would hike rates if it weakens further. MSzP and SzDSz may tomorrow, so the rally may start already at the end of this week in an optimistic scenario. Risk is the delay of the negotiation process, which may keep the political uncertainty here for longer and could keep the pressure on the forint, especially after the Czech political situation became less stable.

The Hungarian bond market followed the currency in appreciation and yields lowered about 30-50bps across the curve. Absolute yield levels are still close to historic highs, like about 12% at the mid-part and 11% and the long-end, while the gradually narrowing 5y5y forward spread could signal that dip in confidence in the Hungarian convergence story is probably over the worst. Bond market outlook is similar to the currency, so if the minority government gets support, there could be a positive trend, while there is clearly the risk of having early elections, which may lengthen the current uncertainty, though it may not be so bad at the end.

Poland

The Polish zloty stayed in a narrow range above 4.50 EUR/PLN. The Polish currency managed to ignore the political turmoil in neighboring countries, especially the Czech non-confidence vote and might have taken some profit from the deal of Romania with IMF on budget deficit target for 2009. We believe moderate negative correction might be possible today as foreign investors may be slowly tempted to underweigh the whole region with the political turmoil escalating both in Czech Republic and Hungary. The main domestic attraction is the NBP meeting where we bet on further interest rate cut. This shouldn’t be too surprising as the market is looking for a 25 basis points rate cut, from 4.00% to 3.75%.

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