Macro Outlook And Fixed Income Update

We forecast that inflationary pressure in the Baltic countries would ease somewhat in November: in Estonian CPI growth decelerated to 4.2% y/y down from 4.4% in October, while in Latvia it remained flat at 4.4% y/y and in Lithuania accelerated to 4.5% y/y, up from 4.2% y/y. The greatest impact on Lithuanian CPI inflation in November will be rising housing maintenance costs.

With the expectation that Baltic economies would slow sharply, new year prices could fall more rapidly as well, pulling CPI inflation down. However, it should be borne in mind that increases in value-added tax (VAT) and excise duties in Lithuania and Estonian would push consumer price inflation up in 2012. In addition, in Lithuania electricity prices are expected to rise about 4-5% in 2012, the direct effect on CPI would be about 0.13 percentage points. The second round effect would push up inflation by an additional 0.1 percentage points.

Turkish inflation set to remain elevated

The past few weeks have seen Turkish yields trading at new 2011 highs, with the benchmark two-year government bond yield crossing the 11% resistance point late last week (highest since mid-2009). The yields have since moderated sharply with the benchmark bond yields easing about 50 basis points on Wednesday alone, as already falling yields increased their rate of descent with the Federal Reserve-led coordinated central banks’ move on Wednesday afternoon.

The general move in bond yields in Turkey has been reflective of both higher inflationary expectations – which have themselves been, to a considerable extent, a by-product of a weaker lira – and softer foreign bond holding levels, stemming from general global risk aversion, as well as the angst felt by the Turkish central bank’s (TCMB) unorthodox policies. As TCMB continues its tightening bias, credit growth shows gradual signs of slowing and compounding with the overall softening in domestic demand, which assists in correcting the external imbalances.

This has, however, been a rather gradual process and inflation – that jumped significantly higher in October, to 7.66% y/y from 6.15% y/y in September – is now set to remain elevated in the coming months. Our estimate for the month of November is for headline inflation to have accelerated further to 9.1% y/y. Our latest estimates see year-end inflation reaching 9.5% y/y and for inflation to average about 6.3% in 2011.

NBP set to keep rates unchanged

It would be an enormous understatement to say that things are boring in the financial markets these days and given the very high volatility in the markets it is very difficult to get any idea of exactly where we are going from here. It is of course the European crisis that continues to dominate the picture, overshadowing everything else. However, while there is nothing boring about the global market, Polish monetary policy looks remarkably “boring” – in the sense that for the Polish central bank (NBP) has more or less been forced by circumstances into an ongoing “wait-and-see” position. On the one hand, the European crisis clearly indicates significant downside risk to Polish growth and inflation. On the other hand, the recent sell-off in the zloty risks increasing inflation expectations and with inflation still somewhat about the NBP’s inflation target of 2½% there is really no out option other than to stay on hold for now. We therefore also expect a “boring” outcome at next week’s rate-setting meeting, where we expect unchanged rates. This is also the consensus.

In Hungary this week, the central bank was forced to hike its key policy rate by 50 basis points, due to the sell-off in the forint. There is no doubt that the continued sell-off in the forint is increasing financial sector risk in Hungary, due to the high level of foreign currency lending. This problem is significantly smaller Poland and is therefore having much less impact on Polish monetary policy.

Russian inflation remains in check

Russian statistics is due to publish November inflation figures next week. According to the weekly figures, inflation has remained under control despite the weaker rouble and the fact that a benign seasonal effect, from lower food prices, is fading. As month-on-month inflation is expected to be 0.5%, year-on-year inflation continues to ease and is likely to be down to 6.9% from 7.2% in October.