Bloomberg News

Inflation Bonds Lose Most Since 2008 on Slowdown: Poland Credit

October 12, 2011

Oct. 12 (Bloomberg) -- Polish inflation-linked bonds are losing the most in three years as slowing growth in the European Union’s biggest eastern economy damps the outlook for consumer price increases.

Bonds with returns tied to the consumer price index fell 1.5 percent since the end of June, lagging behind gains of 8.3 percent in Brazil and 6 percent in emerging markets, Bank of America Merrill Lynch data show. Bondholders pared Polish inflation expectations to 2.37 percent for the next five years from 3.08 percent in July, based on the yield difference between fixed-rate bonds and those linked to consumer prices, known as the breakeven rate, data compiled by Bloomberg show.

Inflation slowed to an annual 4.1 percent in September from 4.3 percent in August, the Statistics Office in Warsaw will report tomorrow, according to the median forecast from 32 analysts polled by Bloomberg. Poland relies on the euro region for 55 percent of its exports and its banks are 66 percent owned by foreign lenders with fortunes tied to the outcome of Greek bailout talks. Citigroup Inc., Goldman Sachs Group Inc. and Fitch Ratings cut forecasts for Polish growth in the past month.

“I don’t see the possibility of inflation skyrocketing and developing into territory that would be dangerous for bonds,” said Jakub Taborowicz, a fixed-income portfolio manager at the asset management unit of PZU SA in Warsaw, Poland’s largest insurer. His $454 million of assets doesn’t include inflation- linked bonds.

Spending Cap

Prime Minister Donald Tusk, who led the ruling Civic Platform party to victory in last weekend’s general election, has pledged to cap public spending growth at 1 percentage point above inflation to help trim the budget deficit. His previous administration froze the wages of government workers, lowered state contributions to private pension funds and increased the value-added tax rate by 1 percentage point to 23 percent.

The government’s draft budget assumes inflation at 2.8 percent next year while the central bank said in July it expects the pace will slow to 2.4 percent in 2013, compared with a previous forecast of 2.9 percent.

Inflation is less than half the 7.3 percent annual pace in Brazil and Turkey’s 6.2 percent rate. The breakeven rate for Brazil hit a three-year high in September as inflation accelerated in Latin America’s largest economy. South African inflation-linked bonds returned 3.4 percent in the third quarter as consumer inflation in Africa’s biggest economy quickened 5.3 percent in August, the highest rate in 15 months.

Depreciation

While Brazil and Turkey surprised investors with interest- rate cuts this year, Polish policy makers have held borrowing costs the past three meetings to shield the exchange rate from depreciation. The zloty lost 10 percent against the euro in the third quarter, the biggest loss among more than 170 emerging- market currencies tracked by Bloomberg.

The National Bank of Poland lifted its main interest rate by 1 percentage point between January and June to 4.5 percent as inflation jumped to the highest in a decade at 5 percent.

It’s too early to talk about lowering borrowing costs because inflation remains “very elevated,” central bank Governor Marek Belka said in Warsaw on Sept. 8. The zloty’s weakening is making it harder for policy makers to control inflation, Belka said on Sept. 22 in comments posted on the central bank’s website.

A cut in interest rates would be “premature” as inflation remains faster than the bank’s goal and the zloty is set to weaken, Zyta Gilowska, a member of the Monetary Policy Council, said in an interview in Warsaw yesterday.

Euro Turmoil

Concern that the euro region’s debt turmoil and a sluggish U.S. economy will undermine the global recovery has lowered inflation expectations in the U.S. and Europe. The difference between yields on five-year notes and Treasury Inflation Protected Securities, the U.S. breakeven rate, fell to 1.45 percent from a 2011 high of 2.47 percent on April 29.

The International Monetary Fund cut its forecast for Polish economic growth to 3.8 percent this year and 3 percent in 2012 in a Sept. 20 report, citing concern an escalation of the euro region’s crisis “would undermine growth in emerging Europe.” The European Commission on Sept. 15 warned the euro-area economy may come “close to standstill at year-end.”

The 17-nation euro economy probably expanded 0.2 percent in the third quarter and will grow 0.1 percent in the fourth, down from an estimate in March for 0.4 percent expansion in both periods, according to the Brussels-based commission.

“Everyone is expecting inflation to be more or less in the central bank target,” Marcin Zoltek, chief investment officer at Aviva PTE, manager of the nation’s second-largest pension fund with the equivalent of $16.4 billion in assets, said in a Sept. 29 Warsaw interview. “Unless you expect tax hikes, inflation will be dropping at the beginning of next year.”

Extra Yield

The zloty advanced 0.2 percent to 4.3157 per euro at 10:38 a.m. in Warsaw. The currency has 7.8 percent since the start of July, compared with the Hungarian forint’s 9.4 percent decline and the Czech koruna’s 1.7 percent slump.

Yields on 10-year domestic bonds fell 1 basis point to 5.68 percent, extending a drop of 22 basis points this month in Poland. That compares with an increase of 3 basis points for Czech 10-year bonds.

The extra yield investors demand on Poland’s dollar bonds over U.S. Treasuries dropped 13 basis points to 286 basis points yesterday. The spread reached 343 basis points, the highest level since January 2009, on Oct. 4, according to JPMorgan Chase & Co. indexes. Poland is rated A- by Fitch and Standard & Poor’s, two levels above Russia and below the Czech Republic.

Default Risk

Poland’s credit-default swaps climbed 143 basis points to 296 basis points between July and September for the biggest quarterly increase since December 2008 as the euro-area credit crisis worsened. The contracts fell 8 basis points to 268 basis points yesterday, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The level was 52 basis points below the average for governments in eastern Europe, the Middle East and Africa included in indexes compiled by Markit on Oct. 7, compared with a gap of 68 on Oct. 4.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Inflation-linked debt pays interest tied to the consumer- price index. When inflation speeds up, the securities pay more interest. Poland’s 15.1 billion zloty ($4.8 billion) of bonds pegged to inflation represent 2 percent of the government’s zloty-denominated debt market, compared with about 30 percent for Brazil and 24 percent for South Africa, according to data compiled by Bloomberg.

Three-Year Low

Poland resumed sales of inflation-linked bonds for the first time in more than two years in December 2010 as investors sought protection against consumer price increases. The government isn’t planning to offer more of the bonds this year, according to Finance Ministry’s debt supply plan from Sept. 30.

The inflation-linked securities lost 1.3 percent between July and September, the most since the last three months of 2008 and lagging behind 4.8 percent gains for emerging-market debt linked to consumer prices, according to Bank of America Merrill Lynch data. The bonds tumbled 13.5 percent in the fourth quarter of 2008 after Lehman Brothers Holdings Inc. filed for bankruptcy and set off the worst global financial crisis since Great Depression. The government’s fixed-rate bonds returned 3.8 percent in the same period, according to Bank of America Merrill Lynch indexes.

The yield gap between Polish 12-year inflation-linked bonds and the closest maturity fixed-rate securities, due in 2022, fell to 2.57 percent yesterday from as high as 3.38 percent in March.

“General perception is that these bonds are much less liquid,” Aviva PTE’s Zoltek said. “It’s always a one-way trade, either everyone is trying to buy or everyone is trying to sell.”

--With assistance from Robert Brand in Cape Town, Ana Monteiro and Stephen Gunnion in Johannesburg, Ye Xie in New York. Editors: Wojciech Moskwa, Gavin Serkin

To contact the reporter on this story: Piotr Skolimowski in Warsaw at pskolimowski@bloomberg.net

To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net


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