News & analysis

European finance ministers failed to reach an agreement on a response to the virus pandemic after a marathon 16-hour conference call that went through last night.

The key areas of disagreement were reportedly over the issuance of a common debt instrument, and the relaxing conditions attached to loans from the European Stability Mechanism. Italy pushed for both measures, but was reportedly opposed by the Netherlands, with the call ending at an impasse. Crucially, Italy’s finance minister Roberto Gualtieri said his nation would not accept sending a final plan to heads of state unless a mutual debt instrument was explicitly mentioned. Eurogroup discussions are set to continue tomorrow, while financial markets have responded adversely to the delay.

A few additional thoughts:

  • It’s possible that the ESM could be funded by individual national debt issuance, which the ECB in turn buys, having a similar effect to the issuance of a Eurobond. However, Italy’s insistence on explicit references to debt pooling highlights the dangers of this approach. If the European Commission, ECB, or Eurogroup manage to force this approach through and then later use it as a means of imposing “Troika” style conditions on Italy, the nation’s fiscal policy will in effect be determined in Berlin or Brussels. This is a situation Italian voters, bruised by a decade of austerity, may reject, leading to default or even an exit from the euro. Money markets in the EU are increasingly reflecting higher counterparty risk, as a possible consequence of relative policy inaction. Spreads between Eurozone interbank lending and safer overnight index swaps widened to their highest levels since the Greek debt crisis in recent days, while Bund-BTP spreads have widened. The fact that this move was not echoed in other comparable currencies suggests increasing worries of counterparty risk within the euro-zone financial system.
  • The upshot of this delay is higher uncertainty for Eurozone capital markets, and a weaker outlook for the Eurozone recovery. Compared to the UK and EU, lending to small and medium businesses is likely to be slower to arrive, and more constrained, particularly if interbank funding markets show signs of seizing up. UK data shows that SMEs have struggled to access Government-guaranteed loans due to overly long processes and strict conditions – in the EU both problems have the potential to be worse. If loan conditions are set at the ESM level, they will be harder to adapt to changing circumstances, or a worsening crisis.
  • Elsewhere, the European Commission itself is reportedly discussing plans to overhaul the EU budget, or Multiannual Financial Framework, to enable more borrowing. The same divides are likely to come up as in the Eurogroup discussions on the ESM: northern nations are likely to insist on attaching conditions to any loans, while avoiding debt pooling. Any changes in the Eurozone budget would be relatively insignificant as a percentage of GDP: the current cap on the budget is 1.2% of gross national income. Under current proposals from EU budget commissioner Johannes Hahn, this would be lifted to 2%.


Eurozone interbank funding spreads tighten faster than US and UK



RUB primed for a rebound should OPEC+ elevate oil and carry conditions improve

Russian local currency bonds and the ruble were one of the biggest overweight calls in the EM asset class last year as investors flooded into EURRUB and USDRUB shorts due to its attractive carry.  The spread of the coronavirus saw a flight to safety in the US dollar and a mass exodus from risk assets, while the collapse in oil prices due to the price war between Russia and Saudi Arabia extended the ruble’s decline. At its worst point in March, the ruble lost a quarter of its value against the dollar in the space of three weeks, while it also shed 20% against the euro in the same time period.

The ruble has recovered somewhat since its large sell-off, trading back under the 80.00 handle against the dollar and 7% better from its lowest close against the euro. While improved global risk sentiment is the main driver behind the ruble’s current recovery, there remain a number of avenues for continued RUB strength.

Firstly, and arguably the largest source of stimulus for a RUB rally comes from developments in oil markets. If rumours are correct and OPEC+ suspend output for up to three months, the recovery in oil markets will send the ruble on a tear. However, even a lesser response from the cartel, such as the previously floated 10-15m barrel per day output reduction, would cause a significant bout of strength. Not only would it strengthen the currency via current account dynamics, but it would also free up room fiscally. Russia’s reserves are the fourth biggest in the world following five years of austerity. While a 300bn ruble fund was set up to assist businesses and citizens affected by the virus, the fiscal stimulus announced thus far only amounts to around 2% of GDP. The government has a further 1.4trn rubles if needed according to Prime Minister Mikhail Mishustin, but further stimulus measures are yet to be released as the government doesn’t want to burn through its cash reserve should its revenue from oil continue to diminish if the price war becomes protracted. Even though Russia has copious fiscal space to open the purse strings and juice economic growth with limited economic consequences, much of this depends on a bounceback in oil prices to make space for such an event.

Additionally, due to the reforms to the central bank’s mandate and the liberalisation of the exchange rate, the latest sell-off in the ruble hasn’t transpired into increased dollarisation in the Russian financial system.

The latest data published by the CBR saw ruble deposits by Russian households increase from January to February, while deposits in foreign currency actually fell from US$96.1bn to US$94.2bn. While this data highlights the de-dollarisation seen prior to the sharp ruble sell-off, Goldman Sachs estimates that the flight towards dollars during the latest RUB slide is limited. While the currency weakness provides an inflationary shock, if domestic households and business refrain from seeking dollars and therefore inflation expectations remain well-anchored, the CBR is likely to look through the transitory inflation shock and keep policy in accomodative territory. While lower rates in Russia take some of the shine off of the ruble’s carry, rate spreads widened substantially over the last month as developed market central banks cut rates to their effective lower bounds. When taken with further liquidity measures injected into the global financial system as banks restart QE programmes, the ruble is likely to continue to receive large portfolio inflows, despite the central bank cutting rates in order to promote growth. The resumption of the portfolio inflows hinges on an improved carry environment, which will undoubtedly resume once global economies begin to return to pre-virus levels of output growth.


No signs of dollarisation yet from the recent RUB sell-off


NBP shelves PLN concerns and cuts rates again

After having cut rates just three weeks ago and having introduced a program similar to the ECB’s TLTRO, market expectations for the National Bank of Poland’s decision for today were to hold the key policy rate at 1.00%. The central bank surprised and cut its rediscount rate by 50 bp to 0.50%, while cutting the deposit rate from 0.50% to 0.00% and the discount rate from 1.10% to 0.60%. Market expectations of no change in the interest rates were among other things justified by the explicit comments of several monetary policy council members just a week after the rate cut.

Jerzy Zyzynski stated that “the space for another rate cut is very limited, and the zloty is one of the reasons”, while Kamil Zubelewicz discussed that “further rate cuts in Poland are a road to nowhere”, as “incompetent actions can consume every amount of money and will always end up calling for more. To take it one step further, Lukasz Hardt argued that “the recent rate cut went too far and reduced the scope for non-standard policy tools.”

While the NBP’s benchmark interest rate has never been this low in history, the surprise move is understandable given the global state of affairs. Although recent inflation figures, retail sales and industrial production printed well above expectations leaving the nation in a better position than neighbouring countries, most of the currently available data is lagged and leads back to February. Poland started lockdown-type control measures on March 10th, cancelling mass events, and expanded these measures on March 25th. As in other countries that introduced containment measures starting in March, the upcoming economic data releases are expected to be significantly worse.

The rate decision comes after Prime Minister Mateusz Morawiecki stated on Wednesday that at least 100 bln zloty of fiscal spending would be used to counter unemployment. Today the government released to boost spending to 14% of GDP (330 bln zloty, $79 bln) by expanding their stimulus package by almost 50%.

The Polish zloty was caught somewhat off-guard and dropped against the euro upon the rate cut announcement, and has shown increased volatility in the hours after. The yield on Poland’s 10-year government bonds dropped to a 1-month low. Additionally, the unexpected rate cut pushes Poland’s real rate to the world’s lowest, bringing real yields to -4.2%.


EURPLN movement on the back of the NBP’s rate cut


The zloty’s depreciation against the euro compared to HUF and CZK – 1 month, normalised (factor 100)


Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Ima Sammani, FX Market Analyst



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