Threat of Latvia's devaluation weighs on CE currencies

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Currencies: Threat of Latvia’s devaluation weighs on CE currencies
Fixed Income: Strong bids in Czech bond auction supported by CNB’s dovish talk

Czech Republic

The Czech koruna extended its losses yesterday despite quite favourable August foreign trade figures (surplus CZK 10.8 bn). There were probably two reason why the EUR/CZK pair moved further north and reached the five-week high of 25.76. Firstly, the market remains terrified by verbal interventions from CNB governor Tuma and secondly the increased possibility of a devaluation of Latvia’s lat.
Today, while the market has shrugged off a release of the September employment figures (the unemployment came in at 8.6 % as expected), the koruna will probably try to erase some of its previous losses. Eventual gains could be, however, be curbed, in case of more negative news from Latvia.

On the other hand, the rally on the Czech bond market could easily continue as investors try to bet not just on CNB rate cuts, but on central bank buybacks of government bonds. The bullish sentiment in the domestic bond market was illustrated by yesterday’s very successful auction of of the 5.70%/2024 government bond for CZK 7 bn. The Ministry sold papers for CZK 10.498 bn., i.e. more than planed volume, although it kept bonds for CZK 2 bn in its book. Demand exceeded supply 2.03 times, as opposed to 1.35 times in the previous tranche of late June. The average yield was 5.276% (compared to 6.112% in the previous auction).
We believe the bond market rally will continue at least till the end of the week as the September CPI report released tomorrow will show negative year-on-year headline inflation.

Poland

The Polish zloty was the hardest hit currency in the region and lost 1% on Thursday. Initial pessimism on the global equity markets weighed on the region. Beside that the zloty did not like the political uncertainty that rose after a scandal over gambling bill triggered resignations in the government and weakens its Prime Minister. Moreover the Latvian problems could have had the negative impact on the Polish market as well. Latvia failed to sell T-bills after the government floated the idea of a law that would limit borrowers' liability to the value of the property. Such a law would make devaluation politically palatable, because it would ease the pain that Latvian households with euro-denominated mortgages would suffer if the lat were devalued.
Although the uncertainty around Latvia can continue to weigh on the region, the global sentiment is clearly positive at the beginning of the earning season. Hence the zloty may try to come back below 4.21 EUR/PLN..

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