Daily analysis 09.09.2016

ECB added some volatility to the market but basic expectations remain the same. Moody’s will most probably leave the rating unchanged. It could cause EUR/PLN to fall below even 4.30 on Monday.

The most important macro data (CET – Central European Time). Macro data estimates are based on Bloomberg information, unless marked otherwise.

• Most probably after 22.00 (it’s entirely possible that it’ll appear earlier, though)

After the ECB meeting

Nearly 24 hours time after the ECB meeting we can view Mario Draghi’s and co. decision in somewhat colder light. The sole fact that the asset purchase program wasn’t prolonged beyond March 2017 needs to perceived as relatively hawkish. However, the whole bank’s statement isn’t particularly positive for the Euro.

The main recurring element in both the statement and the Q&A part is the fact that the Governing Council “commissioned the adequate committees to assess the possible steps that would ensure the asset purchase program to be conducted efficiently”. This almost certainly means the change of both the rule of ECB maximum involvement in a specific country’s bond emission at the level of 33% and the fact of buying debt instruments with yields above -0.4%.

Such decision would ensure a potential increase in the range of purchased bonds. It could decrease their yield even further and effectively be negative for the Euro. The Committee chose a solution that will ensure a more comprehensive operation overview in the future. It’s probable then, that after one of the nearest meetings we’ll learn about extending QE and modification to the aforementioned conditions.

Until that time comes, Euro’s exchange rate will be relatively stable. The behaviour of the Dollar could affect EUR/USD in a bigger manner, considering the looming FOMC meeting. ECB actions could be negative for the pair in the fourth quarter, though, and coupled with expected December FED rate hike could push EUR/USD even in the 1.10 range.

Moody’s decision

Moody’s will publish its decision regarding the credit rating of Poland most probably after 22.00. Because the outlook for the rating is negative it means that, historically, it’s been downgraded within a year’s time in around half of the cases. However, we can assess more precisely the risk of a downgrade based on the arguments that contributed to the change of the outlook and that could actually mean a downgrade.

Moody’s downgraded the rating’s outlook because of the fiscal risk related with rising expenditures. The focus was on the child-benefit subsidy“500+”, plans of increasing the free tax allowance and decreasing the retirement age.

The agency stressed the fact of deteriorating investment climate, connected with dispute regarding the nation’s constitutional court and plans of conversion of foreign-currency denominated mortgages, which could cost the sector 66.9 billion zloty.

Beside the elements that caused Moody’s issue of a negative outlook, they also signalled what could change the rating itself. “A deterioration in the government's fiscal position and/or material impairment in the investment climate following the implementation of the government's proposed measures could generate downward pressure on the rating and lead to a downgrade. Concurrently, a protracted (or escalation in) the conflict between the government and the constitutional court that leads to substantial capital outflows could also exert downward pressure on the rating.” - the agency wrote.

With regards to the part that caused the outlook to be downgraded, it’s worth noting that expenditures are really higher than they were in 2015, because of the costs of the child-benefit subsidy “500+” for one (23 billion zloty in 2017). The free tax allowance issue is somewhat unclear. The government wants to modify the whole tax system from 2018, and from the information coming from some of the government’s ministers, we can gather that it’ll be budget-neutral – meaning that some groups will pay more, while some less. The free tax allowance, even if increased, won’t extend the country’s deficit. One can say that this threat won’t materialize.

Lowering the retirement age could pose a bigger problem though, because it’s a constantly rising cost that would amount to 10 billion zloty in 2018. However, there’s a noticeable discord among the government itself regarding the proposal itself. The Ministry of Finance would want to limit the possibility of going on an early retirement by introducing a seniority criterion. This could decrease the proposal’s cost by half. For the time being, the government appraised the project, and the budget has been constructed so it could cover higher retirement expenditures from the fourth quarter of 2017. Moody’s could lean towards the costs being considerable, around 0.5% GDP.

Up until now one could say that maintaining a negative outlook today will be justified. Looking at the other reasons we see the issues related with the constitutional court and foreign-currency mortgage loans. The first remains still relevant. The second one should be rather perceived as an easing of the former position. An automatic conversion of the aforementioned loans is currently highly unlikely, which should significantly reduce the expected cost to the financial sector estimated earlier at 66 billion zloty.

The agency points to the risk of deterioration of the fiscal situation as a catalyst for downgrading the rating. It appears that this isn’t currently the case. Moody’s estimated the public sector deficit to be at 2.8% GDP in 2016. It’ll probably be closer to 2.5%. The year 2017 is still a question mark, but the government appears to be relatively determined not to exceed 3.0%. It can be concluded that the fiscal situation hasn’t worsened, so it shouldn’t be an argument for cutting down the rating.

The second issue is related with the country’s constitutional court. While it’s true that the situation isn’t improving, it doesn’t rather cause the outflow of capital from Poland as well. Feeble investments remains a question mark, many signs point to them being really related to the transition to the new EU perspective, and not to private sector constitutional court anxieties. Those conceptions are underscored by Hungarian data where investments decreased even further than in Poland.

As a result, taking into account all arguments, we estimate that Moody’s will leave the negative outlook, but won’t change the rating itself. In the context of Zloty, it should cause it’s appreciation and a decrease of EUR/PLN to the level of 4.30. if our base scenario doesn’t check out, we could be paying for the Euro more than 4.35 Zloty on Monday morning.