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Daily analysis 29.02.2016

29 Feb 2016 13:28|Marcin Lipka

Readings on inflation from the euro zone appeared to be significantly lower than expected. China is cutting the rate of obligatory reserves. Is it a good moment to strengthen the dollar? The GDP reading from Poland should decrease a chance for cutting interest rates by the MPC in forthcoming months.

Most important macro data (CET – Central European Time). Estimations of macro data are based on Bloomberg information, unless marked otherwise.

  • No macro data, which could have a significant impact on the analyzed currency pairs.

Increasingly lower base case inflation in the euro zone

Before noon, the ECB received another argument for performing a deeper than expected monetary easing in the euro zone, at the meeting in March. Today's data on inflation shows not only a decrease in prices of raw materials, but also increases in prices of products and services with the exclusion of fuel and food, which are close to the lowest in history.

A general reading in February on inflation in the euro zone was negative 0.2% y/y, while the expectations were at the level of 0.0% y/y, and January's publication was +0.3%. A significant overvalue of raw materials is partly responsible for this depreciation. It caused the component of retail costs of energy to decrease by 8% y/y. This effect can be considered as temporary, because the prices of oil and gas cannot decrease endlessly, and the reaction of monetary policy for external factors related to costs of raw materials, is inefficient in most cases.

Readings on the base case inflation are much more significant in the context of the future actions of Mario Draghi. Retail prices, with exclusion of fuel and food, increased only 0.7% y/y. This is 0.3% less than in January's publication, and 0.2% less than the consensus of economists. Moreover, the base case inflation is only 0.1% above the historical minimum, reached at the beginning of 2015.

Thus, the ECB receives a strong argument for easing the monetary policy to a greater degree than the market expects. The scenario, in which the European monetary authorities decide to decrease the deposit rate (it may go even to 0.5%), as well as increase the monthly purchase of assets from the market (even by additional 20 billion euro per month), is becoming more likely.

It is also possible that the entire QE will be extended beyond March 2017. If Mario Draghi announces all of these elements at the meeting on the 10th of March, the chances for an overvalue of the EUR/USD will clearly increase. With an improving global sentiment, the scenario of reaching the area of 1.05 could become true in this year's second quarter.

China is cutting the rate of obligatory reserves

After the G20 meeting, the majority of comments suggested that the published announcement did not include a clear suggestion about a possibility of an increase in fiscal stimulation, and actions increasing volatility in the currency market. On the other hand, the recently worse condition of the emerging markets is most likely significantly less of a danger for stabilization of the worldwide economy than the 2008/2009 crisis, or the 2011/2012 events in the euro zone.

Moreover, the G20 decided to decrease the impact of the monetary policy. According to the announcement, “it cannot achieve a balanced growth by itself.” However, this suggestion mainly concerned the countries, which currently have a small range to decrease the costs of financing the economy.

Thus, once again China decided for monetary actions, and at approximately 11 o'clock it announced a decrease in the rate of obligatory reserves by 50 base case points. Theoretically, that should increase the range for the commercial banks to increase loans, and reduce the cost of these operations. This may also mean that Beijing plans to decrease interest rates in the near future.

Milder monetary conditions in China should take the risk of lower than expected economic increase further. This, on the other hand, should have a positive impact on the market of raw materials, and should support the stock market indexes. However, considering the business cycle of the developed economies, the American dollar should become a beneficiary of this move very soon. The USA has a higher increase in prices and salaries. It is because the United States are already developing according to the potential, and this country's level of unemployment shows full employment. As a result, if the global fear decreases, the Fed should return to the concept of monetary policy tightening as soon as possible.

Combining this information with the forthcoming ECB meeting, on which the monetary conditions will probably be eased, we may once again observe a bigger depreciation pressure on the EUR/USD.

The zloty remains stable

Today's GDP data for the four quarters was consistent with the previous estimations of the Polish Central Statistical Office (GUS). The Polish economy developed at a pace of 3.9% y/y. The reading's components also show a balanced growth. Consumption in the households sector increased by 3.1% y/y, gross expenses for durable goods increased by 4.9%, and in the last three months of the past year, export was positive 9.1% y/y. The above data should decrease the chances for cutting interest rates by the Monetary Policy Council.

The scenario of the EUR/PLN going down to the range of 4.30-4.35 from 4.35-4.40, which is currently observed, is still real. Today's data on inflation from the euro zone also supports this concept. This increases the probability of the easing of the monetary policy by the ECB in March. This should support the inflow of the wallet capital encouraged by an increasing disproportion in interest rates between the EUR and the PLN.

29 Feb 2016 13:28|Marcin Lipka

This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without acknowledgement of the source is prohibited.

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