Afternoon analysis 04.11.2014

The European Commission lowered its forecasts for the euro zone and Poland. The zloty was little changed before the MPC decides on the interest rates. The Polish government sees budget gap below 3 percent of GDP in 2014. A somewhat poor data from the US.

The GDP in the euro zone will grow 0.8 percent in 2014 and 1.1 percent in 2015, according to autumn forecast from the European Commission published today. The expected growth was lowered from 1.2 percent and 1.7 percent, respectively.

Moreover, the EC cut projections for Germany and France. In case of the French economy a lack of significant GDP growth is not surprising, but there is some uncertainty about its public finance. The projected government deficit will surpass a 4 percent of GDP level, what poses an additional risk for the outlook of the government financial sustainability. The worst case scenario is a cut of Paris's sovereign rating in the future, what would hurt the euro.

Given a low inflation environment, the EC expects that price growth will remain subdued at 0.8 percent in 2015. This forecast is lower from the European Central Bank's projection of 1.1 percent. One can see this situation as a way to increase pressure on the ECB to use additional tools to spur price growth.

On Thursday the ECB is scheduled to decide on interest rates. No change of the interest rates and other policy tools is expected. Nevertheless, the ECB president Mario Draghi may unveil some clues on whether the central bankers deliberated on expanding a scope of asset classes to purchase.

A few weeks ago rumors that the ECB may buy corporate bond jolted the currency markets. This move seems to be acceptable for the Bundesbank, that is opposed to purchasing government bonds. So it may pave the way for the Mario Draghi's plan to expand the ECB balance sheet by 1 trillion euro as a measure to restore cred action and ultimately ward off deflation risk.

If Mario Draghi provides some hints that the ECB considers a similar plan, the euro will extend losses against the dollar. Conversely, if the ECB gives no clues, the euro may post some gains, but it will eventually continue to drop against the US currency, but in a slower pace. The Federal Reserve is heading in a total different direction than the EBC does, what poses significant upward pressure for the dollar.

Today's US data was a somewhat disappointing – both trade deficit (minus 43 billion against 40.2 expected) and industrial orders (minus 0.6 percent as projected) missed estimates. That sent the EUR/USD higher. But given the current situation, the move will be rather limited.

Ukraine may weight negatively

The Ukrainian authorities are very upset after the vote held in easternmost regions of the country on the weekend. The president Petro Poroshenko said that the elections were in violation of the agreement signed in Minsk two months ago. Moreover, the head of country warned that the rulings that gave more autonomy to Donbas region may be revoked.

In the meantime, Russia recognized elections, what poses additional risk that the West will impose new sanctions on Russia. This factor will weight negatively on trade in the CEE region. Currently, the crisis is reigniting, what may lead to a return of heightened volatility observed in the earlier stages of the Ukrainian standoff.

The Polish GDP will rise 3 percent in 2014 and 2.8 percent in 2015, according to the European Commission. The autumn forecast is lower than it from May, when the EC expected growth at a pace of 3.2 percent and 3.4 percent, respectively. The forecast pointed at headwinds from the poor performance of the euro zone and sanctions against Russia. However, the labor market will be strong as the unemployment rates is projected to drop to 8.8 percent from 9.5 percent currently.

The Polish minister of finance Mariusz Szczurek expects the budget gap to be below 3 percent of GPD in 2014, a level that is expected by the European Commission. The government's optimism on the budget pushed bond yields at new lows on record.

The zloty awaits the Monetary Policy Council decision on interest rates. We expect the MPC to cut rates by 25 basis points, what will conclude a whole easing cycle (a broader view in our morning commentary). This will strengthen the zloty in the short term, but in the longer term the Polish currency will continue to fall against the dollar and it will stabilize against the euro at low level.