Afternoon analysis 12.01.2015

Mounting speculations concerning QE before ECB's key decisions. The zloty lower before MPC meeting.

The January European Central Bank meeting is getting closer. Within more than a week (January 22) the European monetary authorities will finally decide on launching the full quantitative easing – asset purchases program than includes government bonds. Still, there is no information on the total amount to be bought, the scope of intervention and rules governing the program.

Recent rumors said the upper bound of QE will amount to 500 billion euro. This sum looks balanced, given opposition from the Bundesbank. However, it surely won't please investors, what may lead to deterioration of sentiment and could result in a stronger euro.

The Federal Reserve during its three rounds of QE expanded balance sheet from below one trillion dollar to around 4.5 trillion in the end of the program. Thus, 500 billion euro (less than 600 billion dollar) is a significantly smaller amount and earlier launched ECB interventions didn't affect balance sheet so efficiently and didn't result in a rebound of private credit.

Moreover, the ECB is in more difficult position than the Fed, the Bank of England and the Bank of Japan. In these financial systems – differently form the euro zone – there is only one issuer of government bonds. In turn, in the monetary union there is currently 19 issuers that differ in the quality of bonds due to variety of rating grades. Bonds issued by Germany are not similar to papers from Greece or Spain.

However, this problem may be tackled by a decision to buy a portfolio of bonds comprised of each countries' debt in accordance to paid in capital, according to CNBC.

However, this solution is flawed – the major recipients of support for the ECB will become countries that hold the largest stake in central bank's capital – for example Germany (17.9 percent) and France (14.2 percent). On the others side will be countries in the need for support like Greece (2 percent) and Cyprus (0.15 percent). As a result, the impact on the economy of similar actions will be rather narrow, and may be severely criticized.

The European Court of Justice's opinion

On Wednesday (14. January) the European Court of Justice will issue an opinion on the Outright Monetary Transactions program – a conditional bond purchases program that ECB announced earlier. The opinion will be followed by ruling within next four to six months. The case was referred to the ECJ by the German Constitutional Court that assessed OTM as a violation of the European law due to possible financing of public debt.

If the opinion is not favorable for the OTM (even if its non-biding), it will surely affect the shape of the QE. As a result, any opinion that lowers the likelihood of bond buying in the monetary union, will result in a stronger euro.

The zloty hit again

After quite good second part of the previous week, the zloty weakened on Monday. The Polish currency was negatively affected by a significant slide of the euro that is near it nine-year low and increased risk aversion (reflected in drop of the US and European stock markets).

On Wednesday the Monetary Policy Council will decide on interest rates. Any change of policy stance is not expected, however the MPC is expected to assess the impact of the European QE, record low inflation (data is scheduled on Thursday; inflation stood at minus 0.9 percent, according to expectations) and heightened volatility in the zloty market. If the MPC says that these factors don't contribute to additional risk for the price level and the economy, the zloty may be strengthened.

Next few days will bring some important events, that may significantly affect the broad market. The zloty will remain more susceptible for external factors than domestic ones. The Polish currency should stabilize against the euro at low level and may post additional losses against the dollar.