ECB Dust Settles to Reveal Unshaken Policies in East Europe

  • Little change needed in policies, Capital Economics says
  • Bets on future borrowing costs unchanged from pre-ECB levels

While tremors shook Europe’s emerging markets after Mario Draghi announced new monetary stimulus on Thursday, the region’s central banks remain unmoved on how they’ll tackle policy this year.

Investors increased bets on more monetary easing from Warsaw to Budapest after the European Central Bank cut borrowing costs and extended its asset-buying program. They quickly reversed, however, after Draghi said he didn’t see a need to lower interest rates further, decoupling the region’s assets from other emerging markets.

The ECB president effectively quashed concern that Polish, Hungarian and Czech assets -- which offer higher returns than negative-yielding euro counterparts -- would attract inflows that would drive down inflation that’s already below target across the region. While many economists had earlier predicted the need for monetary easing across eastern Europe, the consensus now shows little deviation from the policies that prevailed before the ECB met.

“I don’t think it’s fundamentally changed anything,” William Jackson, from London-based Capital Economics, said by phone on Friday. “Further ECB easing was expected to some extent and each policy board and their relative dovishness or hawkishness will determine whether there will be further easing or if they’ll just keep their policy loose.”

Poland was the first to take a pass on Friday, as policy makers left the main rate unchanged at 1.5 percent. Still, that doesn’t mean that everyone will stand pat. Hungary’s central bank, which vowed last year to keep its benchmark rate unchanged through the end of 2017, will probably resume cutting from the record-low 1.35 percent this year, Vice Governor Marton Nagy said Thursday before the ECB decision. The bank, which holds its next rate meeting March 22, will adjust overnight rates “imminently,” he said.

Swinging Expectations

Market bets illustrated there’s little need for damage control. While some currencies surged, emerging Europe underperformed other regions. The forint has weakened 0.4 percent against the euro in the past two days while the leu and the koruna have been little changed and the zloty is up 0.3 percent. The ruble and South Korean won, which mainly trade against the dollar, have rallied at least 0.8 percent in the period.

Forward-rate agreements, which investors use to bet on future borrowing costs, erased an initial jump in expectations of further monetary easing on Thursday. They now indicate that Hungary and Poland will cut by around 30 basis points by December, little changed from levels two days ago. Czech FRAs signal 15 basis points of reductions, compared with 26 basis points the day before the ECB move.

Polish Newcomers

Poland’s Monetary Policy Council didn’t budge Friday as it sat for the first time this week after eight of its 10 members were replaced. The council last cut the rate by half a point to a record low a year ago and then deferred any action to its newly constituted successor. Policy makers there perused new economic projections and must balance the prospect of easing with the impact it may have on the financial sector.

“The new MPC is in a difficult situation at the start of its term,” Maciej Reluga, chief economist at Bank Zachodni WBK, said by phone. “Meeting the inflation target sets the case for more rate cuts, while worries about financial stability show rate cuts as possibly dangerous.”

To the southwest, the Czech central bank has been intervening in the market since July to prevent the exchange rate from gaining beyond its Swiss-style cap at around 27 per euro, imposed in 2013 to avert deflation. Rates setters in Prague have repeatedly questioned whether negative rates would be useful and Vice Governor Mojmir Hampl said they first needed to see the market’s reaction to the ECB move.

“The overall mix of these measures doesn’t for now, in my personal opinion, dramatically change the situation for our further monetary policy considerations and the decision at the end of March,” Hampl told newspaper Lidove Noviny on Friday.

Romania, which has the highest key rate in the region at 1.75 percent, is already “divergent” from the ECB because of accelerating inflation, Lucian Croitoru, monetary adviser to Governor Mugur Isarescu, said Thursday by phone. Isarescu himself said a period of tax-induced deflation may prompt his board to actually tighten its policy “sooner than expected.”

“We’ll soon be in a position similar to that of the FED in relation to the ECB, we’ll be in a tightening mode,” Croitoru said. “It’s not a major problem that we’re out of sync.”

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