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Weekly CZK Report - Battle over debt limit

Weekly CZK Report - Battle over debt limit

29.7.2011 16:53
Autor: Tomáš Vlk, Patria Finance

Debt crisis remains in the spotlight. Attention is mostly focused on the US and their debt limit issue. The battle is not over yet, after some proposals were turned down and voting about the last one has been put off. This proposal, by House speaker John Boehner, may be passed in the House but has a little chance in the Senate. It can still lay foundations for a compromise plan, but a risk is mounting that the agreement will come too late. The US Treasury is, therefore, preparing an emergency plan for the case the debt ceiling is not raised in time. As the debt deadlock continues, the US risk losing their AAA rating, the rating agencies have already warned. The risk will be there even if the limit is finally raised.

The Eurozone debt crisis was overshadowed by the US issue, but recently it has come back on the scene. Italian and Spanish bond yields are rising again and get back to the levels we could see some two weeks ago when contagion threat hit the markets. German finance minister Wolfgang Shäuble said that the extended mandate of the EFSF did not mean automatic purchases of bonds on secondary market. Such purchases must only take place under very tight conditions, he said. Moreover, the EFSF was empowered only in terms of mandate, not of size. This raises doubts whether the fund will be sufficient for all the risks it is supposed to cover. Moody´s has put Spain on review for a possible rating downgrade and the last auction of Italy´s sovereign bonds was not successful, which fueled market pressure, too.

Initially, the dollar was sold against the euro, later on the Eurozone debt issue started to weigh on the single currency again and the pair went back down. At the end of the week, very weak data from the US economy boosted risk aversion, but also influenced negatively expectations about the Fed policy. The immediate reaction of the euro-dollar rate was mixed, but then the data turned negative for the dollar.

The CE currencies were also influenced by market reaction to news about both the US and the EMU debt crisis. But the overall impact is not very big, although the forint and zloty suffered some losses. The koruna went its own way. The currency is considered less risky than its peers and the Czech central bank holds interest rates very low. Thanks to this, position of the koruna is somewhere between an emerging-market asset and a regional safe haven. It seems that the latter character has prevailed this week and the koruna has strengthened.

The CNB will decide on rates next Thursday. After local inflation has decreased and more signs of economic downturn have come from the western economies, the bank is expected to keep rates unchanged. The hike is expected to come later, in the 4Q.

If the debt crisis and bad economic news keep world markets under pressure, the stable rates might help the koruna to firm further. However, as it is not a typical safe haven, it would probably find hard to pass the 24.00 mark. If market sentiment improves, the koruna should start tracking the region again. There are many important events on the agenda that will influence the markets: the US vote about the debt ceiling, labor market data and the ISM report. Moreover, the ECB holds a monetary meeting and may comment on the recent rescue plan for Greece and the measures against contagion.

In the Czech Republic, the CNB meeting has a little chance to surprise. New data – retail sales and the PMI – should worsen compared with the previous readings, but their influence will likely be marginal.

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