Rates and FX Outlook - September 2016
In September's Rates and FX Outlook:
• Poland’s GDP growth failed to accelerate in 2Q16, with investments surprising negatively (-4.9% y/y), and we think that the second half of the year will see no significant improvement in economic growth. Although private consumption is likely to gain strength in the coming quarters, supported by solid labour income and the new child subsidies, it may take time until investments recover, and the positive impact of net exports will be hard to maintain (export growth may decelerate and imports accelerate). We expect a more significant investment pick-up next year, but by then the impact of the 500+ child benefit programme on consumption will be dissipating. Therefore, we forecast that GDP will grow 3.1% in 2016 and 2.9% in 2017.
• Such a pace of economic growth should be quite surprising for the Monetary Policy Council. We point out that at its last meeting in July, the panel was confident that GDP growth would be significantly better than envisaged by the NBP projection and would accelerate later this year. Nevertheless, we doubt if the first central bank meeting after the summer break will pave the way for further policy easing, as even the most dovish Monetary Policy Council (MPC) members seem to doubt that further interest rate cuts would be effective and think that low inflation does not have a serious negative impact on the economy. Meanwhile, deflation has probably already passed its trough, and we expect the CPI to gradually climb towards zero in the coming months.
• The MPC’s Marek Chrzanowski resigned from his post for personal reasons. His replacement is not known yet, so it is hard to guess whether this will tilt the balance of votes significantly.
• The government’s draft budget for 2017 assumes a fiscal deficit of 2.9% of GDP. Some of its underlying assumptions (economic growth forecast, expected rise in tax collection) seem optimistic, but overall the budget deficit is not unachievable, in our view. Meanwhile, this year’s budget deficit may be lower than planned by up to PLN10bn.
• The last two weeks saw a sizeable sell-off in the Polish debt market, and we think a rebound is likely. The room for yields to decline may be limited until Moody’s rating decision on September 9, but we do not expect a rating downgrade, so a marked strengthening is possible later on, especially if the ECB announces additional stimulus measures at the next meeting.
• We see more risks for PLN depreciation than factors that could trigger its strengthening in coming months, but the lack of a rating cut by Moody’s on September 9 may trigger a short-term currency gain. Later on, the zloty may suffer from both global and local factors. The former includes a looming Fed rate hike before year end, and the latter, disappointing economic growth, political uncertainty and possible speculation about interest rate cuts.
Rates and FX Outlook - July-August 2016
In July-August Rates and FX Outlook:
• The post-Brexit market turbulence did not last long. Growing hopes for more monetary stimulus by the main central banks triggered a rally in the bond markets with Polish bond yields falling to April lows and the spread vs the 10Y Bunds returning below 300bp. EM currencies also rebounded, although the zloty and the CEE region's currencies gained less than, for example, their Latam counterparts. They were probably held back by worries about the looming economic slowdown in Europe as well as some country-specific risk factors (see below).
• In our view, the risk for Poland's growth outlook is indeed rising – GDP growth in 2017E-18E may be closer to 3% than to the government-envisaged 4%. 2016E may also be weaker, as recent data disappointed (1Q only at 3%) and high-frequency figures for 2Q have signalled that the 2nd quarter may not be much better. Additionally, Brexit poses a risk for the Polish economy due to a direct impact through the trade channel amid high exposure to the British market in foreign trade (c7% of the total exports and high trade surplus) and an indirect impact of a risk of the euro zone's slowdown. Overall, we have revised our GDP forecast for Poland by 0.3-0.4pp in 2017E.
• The Monetary Policy Council kept rates on hold in July. More interestingly, the new NBP projection assumes that inflation will rise gradually with the mid-point of the projection for 12M CPI in 2018 at a mere 1.5%. This means the central bank expects inflation to be below the 2.5% target for more than two years going forward. Also, the GDP growth forecast was lowered by 0.6pp for 2016 and by 0.2pp for 2017. It seems MPC members have a more optimistic view of the GDP outlook than suggested by the NBP model. In our opinion, if the next economic data confirm that a significant acceleration of growth is not very likely, market expectations for rate cuts will grow, being positive for the front end of the curve. The FRA market has already started to price in a rising chance of rate cuts. The next MPC meeting in September will take place after the 2Q GDP data release but we do not think a change in interest rates is possible just after the summer break. In November, however, the new projection for the NBP will be available and if it confirms a weaker growth scenario (in line with our forecast), the MPC might consider an easing then, given the no-inflation environment. Historically, the Polish central bank has not been forward-looking in the decision-making process, but we believe a 50bp cut might be delivered at the turn of 2016/17.
• The MPC's decisions will be complicated further by the zloty's depreciation and the possibility of CHF-loans conversion. The latter issue is still alive and even if the head of PM Chancellery said recently that any project will require consultation with the KNF (limiting the risk of big losses for the sector), this would probably still prevent the zloty from strengthening in the following months. Also, lower economic growth and some fiscal risks (though higher tax-free income will not be increased starting 2017) are arguments in favour of a higher EURPLN path as compared to our previous forecasts.
• The government presented the plan for another overhaul of the pension system in Poland (see page 6). This caused some short-term negative market impact (zloty, equity), but it is certainly less harmful than expected by some market participants (risk of "nationalisation"). We believe it should be neutral for bonds and the zloty in the short term.
The next Rates&FX Outlook will be released in September.