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How much will the currencies cost? Central banks make crucial decisions [CINKCIARZ.PL ANALYST'S OPINION]

3 Dec 2015 10:45|Conotoxia.com

Forthcoming days on the currency market appear to be very interesting. During two following weeks the central banks from the United States, eurozone and Switzerland will make crucial decisions regarding the monetary policy. They may have a big impact on rates of the leading currencies – the dollar, euro and franc. How will the market behave? - a comment from Marcin Lipka, Cinkciarz.pl currency analyst.

It is very possible that the European Central Bank (ECB) will make the decision regarding the monetary easing today. What does this mean? In the environment of zero interest rates, it will demand an increase in purchase of treasury bonds from the market, and a decrease in deposit rate. The aim is to reduce the costs of financing the economy, and encourage the banks to give loans. In long term it should stimulate activity of companies, and also increase employment.

However, before there are any positive effects, there will be a wear off on the currency, which is the side effect of this process. During the past one-and-a-half year the euro lost 13% to the main currencies. However, it is possible that this overvalue may increase. According to the surveys among economists conducted by Bloomberg and Reuters, and the statements from the perticular ECB members, it is possible that the monetary easing will increase. The American monetary policy is going in a totally opposite direction. It is mainly a result of the fact that unemployment in the USA is on the level of 5%, whilst in the eurozone it continues to stay clearly above 10%.

Thus, the FED is suggesting the necessity of initiating interest rates hikes for a few months. It is very possible that this move will be made on December 16th.

Differences in the future monetary policy of these two currency areas, are also shown well on the debt market. When comparing profitability of ten-year-old treasury bonds from the USA (2.25%) and Germany (0.5%) it is clear that the difference in rates is approximately 1.7% per year. Assuming that the loan credibility of both countries is the same, and the profits will accumulate during the following years, this could be a serious argument for many market participants to exchange the euro to the dollars.

Significant uncertainty regarding rate of the franc

Changes in the eurozone's monetary policy may affect evaluation of the franc. Many market participants still have in minds the events from this year's mid January. The perspective of monetary easing in the eurozone was the main reason for resigning from keeping the EUR/CHF rate above the level of 1.20. Thus, it is possible that if the ECB increases the monetary stimulation again, the Swiss National Bank (SNB) will have to continue to decrease interest rates and sell francs.

However, if Switzerland decides that further interventions on the currency market are burdened with too great risk, this operation might be ceases as it was in mid January. In this case we would probably see the EUR/CHF rate in the area of 1.00. The closest meeting of the Swiss central bank is planned for 10th of December.

What does this mean for the zloty?

The zloty is to a definitely greater degree related to the euro than the dollar. It is due to the channel of foreign trade, and also the market of treasury bonds. This means that practically every enforcement of the dollar to the euro, translates to a similar growth of value of the American currency to the zloty.

It is also possible that significant changes can concern the franc's rate. If the SNB resigns from weakening this currency, its rate can very quickly level the evaluation of the euro. This, on the other hand, would cause the franc to cost approximately 4.20 PLN. Even though it still is not the most likely scenario, it is worth keeping in mind. Especially that in mid January practically nobody expected that the SNB will resign to keep the EUR/CHF rate above the level of 1.20.

How can the following quarters look like?

Even though historical events are not always a good herald, the current situation reminds the events from the 90s. At that time, the USA was increasing interest rates, and Germany was decreasing them. The unemployment in the United States decreased to the level of 3.8%, whilst in German it was growing, and at a certain moment it reached the level of 11.7%.

Differences in the monetary policy were confirmed by the dollar index. From the moment of the first monetary tightening it gained more than 30%. Strength of the dollar could also be seen on the zloty. At the beginning of the millennium, the American currency costed more than 4.50 PLN.

For the time being such strong movements are not the base case scenario. However, equalisation of rates of the euro and the dollar by aggressive monetary easing in the eurozone and hikes in the USA, is an increasingly probable development of the situation. This would mean that the American currency may soon cost 4.20-4.25 PLN.

3 Dec 2015 10:45|Conotoxia.com

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