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Recession is now the biggest menace


Investors will continue to be concerned about the fate of excessively indebted countries of Southern Europe, but the focus will slowly shift towards China and the US. The zloty is likely to appreciate in October, but the outlook for the markets at the end of the year is less optimistic. The underlying cause is the looming fiscal cliff, which can severely hurt the US economy.

6 September 2012, the day when the European Central Bank (ECB) officially came into play with Mario Draghi presenting the details of the Outright Monetary Transactions (OMT) whose aim would be to stabilise the debt market of the indebted countries, will likely be the moment that historians of economy will one day record as a breakthrough in solving the European crisis. However, 26 July was a more important date for investors as it was then that the ECB’s head surprised financial markets with a statement released during a minor press conference when he admitted that the central bank could step up its bond buying efforts. With the benefit of the hindsight, it should be noted that the news came at the perfect time – yields on Spanish sovereign debt jumped to all-time highs, so did interest rates on Italian bonds. In addition, great uncertainty surrounded Greece where investors were wondering to what extent the new government led by Antonis Samaras would be able to make savings of billions euros required by international monitors.

Besides, the markets did not quite believe the arrangements adopted during the June European Union summit. It should be recalled that firm declarations on making preparations to establish a banking union were made at the summit, which would aim to increase the role of oversight by the European Central Bank (but, as it eventually turns out, agreement will not be achieved easily – Germany is against the ECB oversight over all eurozone banks and also has objections against direct financing of the struggling banks by the European Stability Mechanism), but the most telling words were those that the distressed countries could expect to obtain support in the form of buying debt with funds from the EFSF/ESM rescue funds. However, investors quickly saw that the European Financial Stability Facility had insufficient resources to fund such operations, while disbursements from the ESM were delayed because the German Constitutional Tribunal withheld its ruling. Eventually, on 12 September the Tribunal ruled in favour of the ESM, but the judges reduced Germany’s liability to the ESM to €190bn – the cap may be exceeded but only subject to the approval of the Bundestag; given a surge in eurosceptic sentiment before the parliamentary elections scheduled for the autumn of 2013, obtaining such approval is virtually impossible.

Therefore, if the European Central Bank, whose financial potential is practically unlimited, did not join the game, we would end up with another mechanism of a questionable efficiency. But as Mario Draghi rightly pointed out during a press conference at the end of September, investor confidence has re-emerged that the eurozone will remain a stable system capable of addressing the crisis.

EUR/PLN and USD/PLN fixing in comparison with WIG20 index, January 2011-September 2012

Fed and US politicians again in the focus of attention

However, the OMT mechanism is no ideal remedy to overcome the crisis, and so is not another round of quantitative easing, known as the QE3, which the Fed introduced on 13 September in response to the continuously disappointing situation in the labour market and too slow economic recovery. Unlike in the previous rounds, there is no time limit on the QE3, which will continue until the Fed believes that the economic situation has improved sufficiently and the potential areas of risk have been contained. The QE3 is a bond-buying plan providing for the purchase of mortgage-backed securities at a pace of $40bn a month. However, opinions have been already expressed that the programme’s scope can be expanded at the turn of the year to include treasuries, which are currently bought under Operation Twist, which is due to expire by the end of December ($45bn). While the hawks within the FOMC, who are critical of policies supported by Ben Bernanke, are likely to grow in number in January, they appear unlikely to have a powerful sway on these policies.

All the more that the US economy can soon face a major issue, which can boost expectations for greater stimulants. If the Congress fails to reach agreement on voluntary spending cuts and fiscal changes aiming to reduce the debt level and address the hole in the budget, previously adopted solutions based on the arrangements of August 2011 will come into force by default. It is estimated that spending reductions and the expiration of tax cuts passed under the Bush administration can set the US economy back as much as $600bn. During the last meetings with the Congressmen, the Fed’s chairman, Ben Bernanke, described the fiscal cliff as the biggest threat to the economy and added that the central bank did not have efficient measures to deal with it.

This explains the balanced response of the markets several weeks after the announcement of the QE3. Investors realise that the end of the year will not necessarily be good because concerns related the Congress failing to reach agreement in time will mount (one month will be left for negotiations because none of the parties will dare to engage in talks during the presidential campaign). The proportion of investors believing that QE programmes supported by the Fed will not be able to effectively boost the economy will grow, too. As the Fed determined that the QE3 will have no time limit, it was automatically devoid of its key element, which the Fed could use in the past two years to successfully “drive market sentiment”. And the range of measures available for future application is shrinking.

Dangerous case of Spain

Potential decision of the European Central Bank to launch the OMT programme and the EFSF and ESM rescue funds, which investors await for Spain, will be conditional upon the satisfaction of conditions which are hard to meet. In the first place, these conditions include formal application which the government must submit and the presentation of a reliable programme of reforms aimed to permanently reduce excessive debt and, above all, a strong political will to implement the programme. Participation in the programme means submission to the oversight by international experts, which the Spanish government, headed by PM Marian Rajoy, will accept very reluctantly. The government is additionally squeezed by internal political pressures.

Public support for the government is declining and local tycoons start to rebel against the programme aiming to tighten financial control over regions, which are mostly the source of the problems facing the Spanish budget. The regional elections in the Basque Country to be held on 21 October and the elections in Catalonia, convened on 25 November, can expose a growing secessionist sentiment and, therefore, impede the execution structural reforms of the economy and budgetary reforms, which are difficult challenges indeed. That the government is reluctant to take too bold decisions is well reflected in the draft budget for 2013, which can be described as unrealistic and bound to be revised several times, which will only add to anxiety in the markets.

Nevertheless, seeing the looming risk of political and economic problems piling up, PM Marian Rajoy can act as a true statesman and submit an application for a new package of aid funds at the next meeting of the Eurogroup planned to be held on 8 October. In the short term, this move could be welcomed by the markets, but in the medium term, it could create new areas of substantial risk. The question is: will international experts deem Spain’s reform programme credible? Will PM Marian Rajoy be able to retain his capacity to carry out the challenging reforms? And, last but not least, what will the ECB and the ESM do if it turns out during the implementation of the rescue programme that the situation in Spain goes in a different direction than originally intended?

Chinese support will come in handy but will not last long

Financial markets frequently focus on issues of a short-term nature while preferring not to look too much into the future. This attitude is well exemplified by the case of China. In the coming weeks, investors will focus on new stimulation programmes initiated by the government and efforts of the People’s Bank of China taken to revive the Chinese economy. However, these measures are of a temporary nature (taken because elections will be held in winter), but they will not help solve the main problem of the credit bubble, which can potentially evolve into a massive global crisis in the coming years.

The condition of the Polish economy will be driven by developments in Germany and the US, not by RPP’s actions

A cycle of interest rate cuts, likely to cumulatively reach up to 100 basis points, is practically set for Poland within the next 12 months – this viewpoint was even shared by Marek Belka, Governor of the National Bank of Poland. As a matter of fact, the only issue to be settled is the timing of the consecutive cuts.

However, the Monetary Policy Council (RPP)’s actions should not be expected to have a rapid effect on the economy. Developments in Germany, whose economic standing is likely to improve in the coming months, will be of material significance for the economic situation in Poland. PMI readings for September and Chinese promises of actions designed to revive the economy of China, which is one of the key markets for German products, show that this could actually be the case. A potential threat to the growth is presented by the risk of the US fiscal cliff’s impact on the global economy. Consequently, concerns are raised that 2013 GDP growth forecast for Poland can be less than 2.2% projected by the Polish government.

Projection of EUR/PLN and USD/PLN exchange rates, October 2012 and 2012-2013
author’s own projection, 2012
October 2012
(end of period)
(end of period)
(end of period)
EUR/PLN 3.98 4.10 4.00
USD/PLN 3.00 3.17 3.20

Marek Rogalski

Chief Currency Analyst

Dom Maklerski Banku Ochrony Srodowiska (

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