Czech koruna welcomes political agreement on lower budget deficit

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Currencies: Czech koruna welcomes political agreement on lower budget deficit 
Fixed income: Czech central bank to stay on hold even though the inflation outlook is improving

Czech Republic

Yesterday, the Czech koruna initially was in a see-and-saw mode. The koruna even lost some ground. Later on, the koruna reversed most of its earlier losses as a political agreement on the 2009 budget had been reached. The heads of the main political parties agreed on changes to Finance Minister Eduard Janota's revised draft budget for 2010 and financial austerity measures, which, if passed, will result in a budget deficit about CZK 170bn. This could bring the deficit (in EU EASA95 accounting rules) to 5 % of GDP, which would be significantly lower than the deficit of the original draft and it is definitely positive for all Czech financial assets.

Today, the interest-rate-setting meeting of the CNB will be the eye-catcher for the koruna. We expect a neutral outcome (for more read the fixed-income section), which should be neutral for the koruna too. Anyway, the CNB should mention the recently strong koruna as anti-inflationary factor, which could be a slightly negative massage for the market.

The Czech yield curve was only little changed yesterday, despite quite interesting news coming from the domestic political scene. Though the talks about the 2010 budget are very important for the bond market, the price action ahead today’s central bank meeting was not significant. In fact, surprisingly the FRA curve moved a bit up and we think this increase will be reversed soon.

We do not expect the forthcoming CNB Board meeting to result in any rate change, even as certain arguments for another rate cut are in place. First of all, there is the deeper than expected economic downturn in the first two quarters of the year (by 1 and 0.6 percentage point respectively, compared to CNB’s forecast). However, these are actually old figures, which the bank can no longer react to. Another argument may be the current inflation development. The inflation was 0.3% lower in August than expected by the central bank. Nevertheless, this is also a past development, particularly the delayed impact of the decline in farm prices on food prices in shops. The third argument in favour of a rate cut is the strong koruna, which has now hit EUR/CZK 25.

A factor that counteracts another rate cut is the rate level. Since last year, the CNB has cut its base interest rate by as many as 2.5 percentage points to the current all-time low. However, these cuts could not yet make themselves fully felt in the economy, due to the delay of the effect (1-1.5 years). In addition, the persisting aversion to risk on financial markets, reflected in higher liquidity premiums, has not yet made it possible to transfer the full effect of the central bank’s rate cuts to market rates. Hence the gap between the CNB’s base rate and market rates may only shrink very slowly, and thus monetary policy effects also remain limited. From this point of view, another cut in the CNB’s repo rate would only have a negligible impact on the economy. 

Hungary

The Hungarian forint remained range bound before the Fed decision between 271.00 and 272.00. Disappointing news about the global oil market sparked a minor weakening trend overnight, but the pair recovered the small loss by the time of opening. The Prime Minister said that he would resign if the Parliament rejects the budget proposal, but added that he thinks this is unlikely because it has already accepted the key changes about taxes and pensions.

The Hungarian fixed income market was not very active either as players became increasingly cautious before the central bank meeting next week. We have seen a slight correction on the money market and the 9x12 FRA tenor is now again traded tad above the key 6.00% level.
There are some interesting developments in the background. The 5y5y forward IRS spread over the euro has widened to 230bps from 210bps this week, which could point for some deterioration of the underlying sentiment towards Hungary. It will be interesting to see whether this will recover first or whether other markets will feel this trend, as well.

Poland

The Polish zloty weakened to a one week low around 4.21 EUR/PLN. It underperformed regional peers on expectations of dividend payouts of Poland’s largest insurer PZU. Beside that also slightly worse than expected retail sales could have weighed on the market. Nevertheless the outcome was not far from consensus (5,2% y/y versus 5,6% y/y) and we dedicate it to more the severe drop auto sales in august. On the other hand, we were positively surprised by a stable unemployment figure (at 10.8%) as we expected the positive seasonal factors to disappear in august. Today the sentiment may remain negative as the global equities lose steam ahead of the German Ifo and US existing home sales. It is important to watch whether the EUR/PLN can close above 4.21 EUR/PLN – this would be a bearish signal that would make us scaling down our short term bullishness on the zloty for some time.

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