QE hands bullets to Central European rate setters

By bne IntelliNews January 26, 2015

Tim Gosling in Prague -


Central European currencies have recovered strongly on the back of the European Central Bank's huge quantitative easing programme. That opens up space for more monetary easing in the region, as central banks scramble for ammunition to shoot down deflation.

The Eurozone's central bank surprised the markets on January 22 as it said it will allocate €60bn per month over the next 18 months to buying sovereign bonds in the single currency area. That will raise the ECB's balance sheet by €1.1tn. The scheme offers a boost to assets in countries with strong trade ties with the Eurozone. At the same time, Central European states are likely to experience capital inflows from investors hunting higher returns.

The action pushed the euro to new lows. At the same time, it alleviated some of the pressure seen since the start of the year on Central European currencies, which have sagged because of the ruble meltdown, the sluggish economic recovery in the EU, and the shock provided by the Swiss National Bank's decision to end the franc's ceiling against the euro.

The Czech koruna gained 0.5% on January 22 to raise it to CZK27.86 to the euro. It has traded at around the same levels since, and sat at CZK27.76 on the morning of January 26. The Polish zloty has had a greater recovery, pushing to PLN4.20, as has the forint, which sits at HUF309.8.

Instant return

The rise of the Czech currency has been capped by the Czech National Bank's almost instant return to its version of monetary easing. The central bank launched an intervention policy in November 2013, in a successful bid to spur economic growth. Based on verbal rather than market intervention, it had pledged to keep the koruna from strenthening to lower than 27 against the euro until 2016. Somewhat surprisingly, the action by the SNB had prompted some to suggest the Czechs could follow suit and remove the ceiling on its currency.

In an interview with Slovak newspaper Hospodarske Noviny, Miroslav Singer, head of the Czech central bank, said on January 23 that "the limit of 27 crowns to the euro will likely remain with us longer than we assumed". The economy will likely continue to import deflationary pressures from the Eurozone, he noted.

While its interest rate of 0.05% matches that of the ECB, the Czech central bank will be wary of any sign that QE could drive speculative liquidity into the currency. The country is also keen to maintain its export advantage and avoid following its regional peers into deflation.

That clearly has the CNB - a conservative beast that prefers to leave the markets to do the spadework  - seeking to keep the koruna capped via verbal intervention. The timing of Singer's comments are little coincidence; the koruna halted its rise to remain at CZK27.80 or so into the afternoon of January 23.

Commerzbank analysts predict the CNB will continue to rely on rhetoric, given it has no space on the rates front after slashing the benchmark to effectively zero in 2012. ”If that fails, we will likely see a move higher in the EUR/CZK floor, possibly to the 29.00 mark,” they write.

The next monetary policy meeting of the CNB is scheduled for February 5. "It is now very likely that timeframe guidance will be officially extended at the MPC meeting - in our view, we should expect end-2016 as baseline," Commerzbank forecasts.

Swiss brake?

Poland's rambunctious monetary policy council has done most to muddle the markets in recent months, with those members pushing for a further cut below the current 2% benchmark almost constantly fighting in the media with their more hawkish brethren. The balance on the panel remains fine, however, suggesting the ECB's move could lead to another surprise at the next rate setting meeting on February 4.

At the same time, the zloty has endured a bumpy 2015 thus far. The SNB's removal of the Swiss franc's ceiling to the euro in mid-January led the zloty to plummet because of the 500,000 or so households that hold mortgages in CHF. The ECB's bazooka helped the Polish currency strengthen 0.8%, moving it from PLN4.32 against the euro to PLN4.22.

Analysts from Bank Zachodni WBK say they expect the zloty to continue to strengthen against the single currency in the coming months. However, it remains stuck against the Swiss currency - the Polish currency fell from PLN3.50 to the CHF to around PLN4.30 earlier in the month - posing a conundrum for rate setters.

With Poland fighting a growing deflation trend, economists agree that the ECB's move increases the chances for a Polish interest rate cut. The Frankfurt-based central bank's benchmark rate is currently at 0.05%, meaning Poland offers a spread of 195bp. The MPC doves are keen to strike; Governor Marek Belka insisted on January 23 to PAP that they "aren't far" from forming a majority.

That said, most analysts maintain the National Bank of Poland won't move until March, when it's due to publish its latest inflation report. With expectations that the current five-month run of deflation is set to extend until at least the middle of the year, the consensus is that the NBP will offer 25bp of easing, to set a new record low of 1.75%.

Heedful of the delicate balance on the MPC, and the recent descent into personal attacks in the media amongst the factions, Belka was careful to note that the rate setters "need to pick the appropriate moment" for any move.

First move

Hungary will offer the first formal sign of the mood amongst policymakers in the region when the Magyar Nemzeti Bank (MNB) meets on January 27. The market will be watching the wording accompanying the announcement in Budapest closely, even if few expect any instant cut to the 2.1% record low benchmark.

Bouyed by its skin of the teeth escape from the Swiss franc fallout, Hungary has enjoyed the greatest momentum from the ECB. The forint sat at a five-week high of HUF309.6 to the euro on the morning of January 26.

Although the speculation has been lower than regarding Poland, a similar deflationary trend has had analysts also ruminating on a return to easing by the MNB. The Hungarian central bank has pledged since it ended a 24-month easing cycle in July that it would hold policy loose to the end of 2015, but has also resisted any talk of further accommodation.

However, the ECB plan has pushed those expectations up a notch. “The market started to re-price the rate cut expectations," KBC analysts note. "[A] 10 bps rate cut is already priced in for 2 months, while within 6 months a 20-30 bps cut is expected." RBS now sees a 50% probability that the NMB will resume its easing cycle in the first half of the year, to the tune of 30-50bp.

However, the central bank is still expected to hold at its upcoming policy meeting. KBC suggests rate setters will want to see the inflation figure for January and how the ECB's decision influenced the Hungarian market before taking any steps.

Analysts at Erste agree. "At this moment it is more likely that the MNB will not yet flag any rate easing, as it strongly committed itself to keeping rates unchanged earlier. If easing comes in Hungary, the earliest time for that could be March," they write.

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