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2018/07/11 / Erste Group Research

3Q18 CEE bond market report

Bond markets in CEE faced another strong wave of repricing in 2Q as inflation
soared, the ECB confirmed its plan to end QE by the end of this year and
investors went into risk-off mode on several occasions (new Italian government,
US tariffs). Not only did yields go up, but currencies have also weakened. Thus,
while the performance of EUR-denominated bonds of CEE countries was rather
flat in 1H18, the performance of local currency bonds adjusted for currency
moves was strongly negative in CEE in 1H18 (-4.3%). The most spectacular
repricing could be seen in the case of Hungarian bonds, as 5Y yields went up
more than 100bp in 2Q18 alone and the forint slid to its all-time low against the
EUR. Croatia was the only country that avoided a negative performance of their
5Y LCY bonds (measured in EUR) in 1H18, partially also because the kuna has
been supported by strong seasonal demand in recent months.

The gradual increase of bond yields in the Czech Republic and Romania was
widely expected, as central banks in both countries started with monetary
tightening quite early. It seems that there will be at least one more hike in the
pipeline in each country in 2H18, as inflation has climbed well above the target
- in Romania, even above the upper band of the inflation target. While some
moderation of inflation is expected in 2H18 due to the base effect, inflation is to
remain above the target. In the Czech Republic, the central bank would need to
see the CZK much stronger (below 25 EURCZK) in order to get inflation closer
to the inflation target. In Romania, the central bank mainly needs to tame
inflation expectations.

Poland does not seem to be in urgent need to start tightening anytime soon. To
be honest, the key rate at 1.5% has not been as low as in other countries.
However, in Hungary, the situation has changed. With normalization of
monetary policy in the US and Eurozone, it will not be possible to run such an
ultra-loose monetary policy as it has been without having an adverse impact on
FX and inflation (which we have seen recently) and putting the central bank’s
credibility into jeopardy. To address these issues, the Hungarian central bank
has already started to compromise on some of its interim goals, such as
targeting low long-term yields. Later, it might reconsider some of its
unconventional measures (i.e. FX swaps) that have been contributing to
financial repression.

The ECB’s quantitative easing program is nearing its end with net purchases at
EUR 30bn a month until September 2018 and EUR 15bn for the rest of the
year. The ECB should not start with hiking interest rates before September
2019. Therefore, it will take some time before we see a more substantial
increase of yields in the Euro Area. However, the much earlier start of
normalization of rates and yields in CEE provides a decent cushion (in terms of
spread) for the time when German yields move up. At present, we see potential
for 30-70bp narrowing of spreads for 10Y LCY bonds in CEE this year.

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General information

AuthorErste Group Research
Product nameCEE Economies Special Report
Topic in focusFX, Macro/ Fixed income
Economy in focusCroatia, Czech Republic, Hungary, Poland, Romania, Serbia, Slovakia, Slovenia
Currency in focusCroatian Kuna, Czech Koruna, Euro, Hungarian Forint, Polish Zloty, Romanian Leu, Serbian dinar
Sector in focus-


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