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Expensive dollar, expensive franc. Can they appreciate even more?

26 Oct 2018 12:53|Marcin Lipka

"Since the beginning of the year, the Swiss currency has risen by more than 0.20 PLN, and the US currency by about 0.30 PLN. The weakening economic situation in the eurozone, combined with market turbulence and deteriorating GDP growth prospects for Poland may cause the dollar and the franc to cost about 4PLN by the end of the year," writes Marcin Lipka, Conotoxia Senior Analyst.

The risk of the economic situation in both the eurozone and Poland being much worse than expected is growing. This is suggested by leading economic indexes and current data on industrial production or retail sales in a growing number of EU countries.

The situation on the Apennine Peninsula is also becoming worse and worse. The cost of financing the new debt in Italy is twice as high as in the first half of this year. In 2019, Rome will have to find buyers for bonds worth around 200 billion EUR. However, investors are becoming increasingly sensitive to the worsening potential of the Italian economy related to the introduction of guaranteed income and the withdrawal of the pension reform.

Italians may also have problems with the banking sector. Depreciating Italian bonds are in banks' portfolios. This may result in the need to raise additional funds to meet capital requirements. This would be much more expensive than if the economic situation were at least stable. However, in a scenario of unproductive fiscal changes or the risk of losing the investment rating, it may even lead to a financial crisis.

Germany ahead of economic slowdown

Although Germany's stability is not threatened and should not be called into question, dependence on foreign economic activity is a severe problem for Berlin.

Recent economic data can perfectly illustrate this. The PMI's production index for German industry fell to 47-month lows in October. The component of new orders for industry according to PMI data is also at 4-year lows, and foreign demand has fallen for the second month in a row, recording the largest decline since June 2013.

Data from Germany is not only a concern for Berlin. Business expectations measured by the PMI index for both services and industry in the eurozone have fallen to their lowest levels since August 2013, and IHS Markit estimates that economic growth in the common currency area in Q3 was only 0.3% Q/Q.

US economy keeps its upward trend

Apart from Italy, most of the eurozone's problems come from external causes. Weak export prospects in the industrial sector are the result of the weaker condition of Asian economies. Asia, especially China, is threatened by a trade war with the United States. This is why investments in the Middle Kingdom and consumption in that country may be much weaker than expected, which has a negative impact on the eurozone, especially Germany, which is the world's leader of export.

The partial "culprit" of this situation is doing exceptionally well. The ISM indexes, which are equivalent to PMI, record historical highs. Entrepreneurs are satisfied with tax cuts and are also investing a lot, especially in the mining sector.

Instead of engaging more abroad, the US industry is increasingly eager to look at its own backyard. This trend is unlikely to change in the coming quarters, as economic forecasts are much more favourable for the US than for the eurozone. The heated US economy also needs higher interest rates, which increases interest in bonds from across the pond. They offer high interest rates and are not at risk of failure, as is the case with Italy.

Euro is unable to compete with dollar

Given the poorer economic perspectives of the eurozone and the low chance of rapid interest rate increases by the European Central Bank, the situation in the United States and the dollar looks even better.

Over the coming quarters, there is little risk that the economic situation in the US will deteriorate significantly, while at the same time there is little chance that the European Union will be able to cope with the problems. Therefore, the dollar is likely to maintain the upward trend in relation to the euro and it cannot be excluded that by the end of the year EUR/USD will fall to 1.10. What consequences could this have on the zloty?

Light is fading for the Polish economy

Since Q3 of 2017, the Polish economy has been growing at a rate of about 5% a year. However, that can now be forgotten. PMI for the Polish industry fell in September to the lowest levels in almost two years. This is to a large extent an effect of the worse economic situation in the eurozone.

In Poland, it is not only the prospects for the industry that are deteriorating. Consumption growth may also decline relatively quickly. By 2019, the effect of fiscal stimulation associated with the Family 500+ child benefit program will expire completely. Already now, the growth in real retail sales in September was only 3.6% - the least since March 2016.

Companies are likely to be less willing to hire and offer raises to their employees in the face of a worse than expected economic situation. Besides, the costs of current operations may significantly increase, for example, due to higher electricity prices. This, in turn, may reduce investment opportunities for Polish companies.

According to calculations by the Jagiellonian Institute, the costs of electricity for manufacturing will increase by about 40% next year compared to 2016 and will reach about 20 billion PLN. At the same time, these costs for services will increase from 13.3 billion to 20.5 billion PLN. In total, the think-tank estimations for all sectors of the economy show that expenditure on electricity will increase from 33.5 billion PLN to 49.2 billion PLN next year and to 55.5 billion PLN in 2020.

Zloty may suffer

Poland's economic growth will decline every quarter. Bloomberg's consensus shows that in Q1 2019 it will be at 4.0% y/y level, and in Q4 it will fall to 3.3% y/y. However, there are far more pessimistic expectations. Moody's Economy estimates that already in Q3 2019 growth will decrease to 2.5% y/y, and in the next quarter to 2.4% y/y. HSBC also expects a serious slowdown at the end of next year - to 3.0% y/y in Q4.

The downward trend is likely to discourage the Monetary Policy Council from raising interest rates, which will have a negative impact on the zloty. A stronger dollar is also usually unfavourable for the Polish currency. Concerns about the condition and cohesion of the eurozone is another set of negative information for the Polish currency, which in turn may increase the strength of the Swiss franc.

As a result, taking into account global and domestic threats to the zloty, the scenario of a continued increase in the value of the franc and dollar and slow depreciation of the zloty becomes more and more possible. Therefore, it cannot be ruled out that in 2018 both the franc and the dollar will reach the 4 PLN limit.

26 Oct 2018 12:53|Marcin Lipka

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