Czech koruna weaker after the government collapse

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Currencies: Czech koruna weaker after the government collapse
Fixed Income: NBP cut as expected by 25 bps, while the CNB will stay on hold

Czech Republic

The Czech koruna weakened yesterday as the market digested the news about the government collapse. Nevertheless koruna losses were limited (less than 2 %) and the EUR/CZK pair was unable to break above the 27.40 level. While the koruna will continue to monitor political developments (particularly steps of president Klaus, who should name a new PM now), today the market might rather focus on the CNB interest- rate meeting. We think that the bank will stay on hold and the Board will be somewhat concerned about economic developments, with the CNB Board likely to suggest a chance of adopting an even more pessimistic scenario. Nevertheless, overall the message from CNB’s press conference should be neutral, which could at lest temporary support the currency.

Yesterday, the Czech yield curve steepened in bearish fashion, which could be a result of both negative consequences of government’s failure and the aim of domestic market to catch price action in core markets. The most interesting event appeared to be, however, on the primary market, as there was the auction of the Czech government bond 4.10%/2011, which was a success. The Ministry of Finance offered CZK 10 bln but investor asked for over CZK 27 bln. At the end the Ministry sold CZK 20 bln, with an average yield of 3.70%, however it let about a quarter in its books. This yield is lower than the previous issue of the same paper in June 2008 (4.828%) but higher that the previous day’s yield (3.576%).

Today, all attention will go to central bank’s regular meeting. The CNB Board is unlikely to change rates at its second meeting of this year, as several CNB Board Members have already made statements suggesting this. The economy is continuing to fall, inflation has completely ceased to be a problem, but the central bank has started to focus on the weak koruna, which was hit by negative sentiment towards the region. Even if rates remain unchanged this time, it is quite likely that the current rate easing cycle is not over yet. But it will not be the message from today’s meeting. Although we can expect that the bank will be somewhat concerned about economic developments, with the CNB Board likely to suggest a chance of adopting an even more pessimistic scenario, the final comments will be rather neutral, which should have neutral impact on the market too.

Poland

The Polish zloty once again remained nearly unchanged in the 4.55-4.60 EUR/PLN area and ignored political turmoil in the neighboring economies. Also unsurprisingly the NBP cut its rates further to the historical low levels of 3.75 %. According to the statement, there is still probably persuasion on the board that the sharp economic slowdown should keep inflation below the target. Nevertheless, opinions on further steps start to differ. Two key members of the MPC Czekaj and Wojtyna gave quite different opinions on the matter. “We cannot rule out that the Polish economy will contract this year, although this will depend on what happens in the global economy,” said Czekaj in visibly dovish comment. On the other hand fellow RPP member Andrzej Wojtyna said that “Until the zloty strengthens visibly, the scope for further cuts is limited”. Overall, we believe that there is not much scope for further easing of the monetary policy and we see the end of the easing cycle at 3.5%. That could be moderately supportive for the zloty in the mid term. In the short term we believe the zloty should take some profit from relative political stability and outperform some of its regional counterparts.

Hungary

The Hungarian forint had a mild weakening in the morning yesterday to 304 after news about the Czech political situation heightened fears about the Hungarian outlook. It later recovered to around 300 on the back of the positive global sentiment. Mr Suranyi still seems to be the most likely candidate for the new PM job, in case Suranyi does not get the support, early elections would come into the picture. President says another minority government would be just short-term solution. Suranyi would like to have support from Fidesz, but Fidesz committed to early elections. Fidesz want early elections with EU Parliamentary elections in June and tomorrow is deadline for that. We do not think it would be bad because new government would have a 4-year term and curing the structural problem of indebtedness does require a medium-term economic program. Poland's case in 2004 was not that bad, PLN rallied throughout the year despite government fell apart in May. Minority government ruled until the election in 2005 Sep and continued on welfare spending cut. Today we may see the outcome!

This morning, Finance Minister Mr Veres has said that there could be need for additional hundreds of billions of spending reduction. Daily Nepszabadsag also wrote that this could amount to another Ft230bn. If this is the case, the market may weaken with the announcement due to the higher budget deficit risk, but subsequent tightening measures could also bring a quick relief.

The Hungarian bond market had a quiet day and yields lowered minor 5-10bps. Negative news about the budget could make things volatile in the coming days, but with quick response from the new government, this could also become a good buying opportunity.

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