Via Societe Generale's FX & Rates Corporate Research,
The possibility of the ECB announcing sovereign asset purchases on 22 January already led Switzerland’s SNB to move pre-emptively last month and introduce negative interest rates. As disinflationary pressures spill over from the eurozone to trading partners in the north and east of Europe, we parse over the central banks that stand ready to act should the ECB announce QE.
Inflation-deflation
The sharp drop in inflation as a result of lower energy prices has not been unique to the eurozone, but important differences have emerged in terms of how quickly prices have tumbled in some countries, responding in different degrees to the resilience of the respective currency, the state of domestic demand and the feed through of cheaper oil. Low inflation and intermittent periods of deflation, for example, have been the norm in Switzerland since the second half of 2011, and falling prices have also manifested themselves in Sweden since November 2012 and for a longer period in Greece and Spain as government measures were rolled out to increase savings and boost competitiveness.
But more recent declines in inflation and falls in outright deflation have occurred in Eastern Europe, resulting in depreciating currencies. Without a credible programme of QE by the ECB and the stabilising of inflation expectations in the eurozone, the exporting of disinflation from the eurozone to its main trading partners in the north and east of Europe will keep central banks pulling the conventional and in some cases, unconventional policy levers.
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As the graph above illustrates, both Hungary and Poland are already observing deflation, and the Czech Republic is close to seeing CPI fall into negative territory in annual terms. Interest rates have accordingly already been cut aggressively to 2.10% in Hungary and 2.0% in Poland. Having lost 2.6% against the EUR already this year, the CZK is the worst performing currency after the RUB. The scope for inflation to stay low is at the heart of our EM team’s bullish view on local fixed income but more bearish view on EMEA FX. The Nordic currencies including the SEK and NOK have already cheapened considerably in real terms and may be due for a rebound over the more medium term, but in the short-term the possibility of further central bank action and volatile oil prices may keep investors steering clear of both currencies.
Central banks queuing up to act?
UK: With 13% of total eurozone exports destined for Britain, the largest trading partner, the disinflationary impact should not be overlooked even though the BoE has drawn a line under further monetary stimulus and is proceeding glacially towards a first rate increase. The sharp fall in UK CPI inflation to just 0.5% in December shows Britain is not immune to the low inflation of the eurozone. There is a strong possibility that further EUR/GBP depreciation and subdued core inflation will keep the BoE on hold for even longer as unemployment falls and real wage growth picks up.
Switzerland: Back in 2011, the SNB was the first central bank to intervene and stop the franc from appreciating against the euro. A floor of 1.20 was introduced to stop the currency from strengthening too far and keeping inflation too low. The central bank was forced to intervene as a result of the turmoil in Russia and the bank’s FX reserves rose by 32.4bn francs last month to a record 495.1bn francs. A negative 0.25% rate on sight deposits was also announced last month and will be effective as of 22 January, the date of the next ECB meeting. However, the bounce of EUR/CHF up to 1.2097 quickly petered out last month, and the pair has not traded above 1.2014 since 7 January. The SNB will soon have to roll up its sleeves again and buy euros for USD or other currency (GBP, AUD, etc). It could reduce its euro holdings (45%) in favour of more USD (29%). Inflation is currently running at -0.3%.
Sweden: The Riksbank has been among the most active in combating low inflation and last cut the repo rate to 0.00% in October. Rates were kept unchanged in December, but in the minutes of the last meeting the Riksbank said it is preparing further measures that can be used to make monetary policy even more expansionary. The measures could be presented with effect from the next monetary policy meeting and could target an expansion of the balance sheet, a negative repo rate or FX intervention. Inflation is currently running at -0.3%. The next policy meeting is on 12 February if oil prices keep sliding.
Denmark: The central bank raised the deposit rate last April and did not follow the ECB decision last June when the deposit rate was cut to negative. The central bank tends to move with every step of the ECB and has previously intervened in the currency market to stabilise the EUR/DKK exchange rate around the 7.46038 target, with a maximum deviation of 2.25%. In practice, the bank has acted to keep the exchange rate within about 1% of the target. Inflation is currently running at 0.3%.
Norway: Norges Bank is the least exposed of the three Nordic central banks to the vagaries of the ECB and is more likely to keep navigating an autonomous and oil-price-dependent course. It cut interest rates to 1.25% in December, blaming activity in the petroleum industry and the amplification of negative tendencies by the sharp fall in oil prices. Inflation is currently running at 2.1%. A rate cut to 1.0% cannot be ruled out at the next meeting on 19 March.
Czech Republic: The fall in CPI inflation has prompted speculation that the CNB may soon raise the EUR/CZK floor from 27.00 and this led our EM team to issue a ‘buy’ EUR/CZK recommendation with a revised 29.25 target. The CNB last noted that should risks of deflation and a systematic decrease in inflation expectations arise it would be necessary to consider moving the exchange rate commitment to an even weaker level than the current 27.0 level. The next central bank meeting is on 5 February.
Poland: CPI inflation fell sharply from 0.3% last June to a (provisional) low of -0.6% in October and November. The central bank last cut interest rates to 2.0%, but the monetary policy committee is reportedly divided 50/50 over whether to lower rates again in January or maintain the status quo. Our economists forecast no imminent policy change. The country takes the largest share of exports from the eurozone (5.1%) and Germany (3.9%) so it is exposed to further falls in eurozone prices.
Hungary: Though CPI inflation fell sharply from 0.2% last August to -0.7% in November, the lowest in CE3, the central bank kept its interest rate at a record low of 2.10% in December for a fifth successive month. The minutes of the last meeting recognised that downside inflation risks have increased but that there was no reason to change the policy stance yet. The bank still favours maintaining the current loose monetary policy stance for an extended period. Our economists forecast no policy changes.
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