By Mike Bird
What happens in the eurozone doesn't always stay in the
eurozone.
On Thursday, the European Central Bank is expected to begin
unwinding its extraordinary monetary stimulus, a process that will
drag central banks from Ivory Coast to Switzerland in its wake.
That could have a knock-on effect on markets, as investors buy
and sell assets in the countries whose monetary policy is most
closely linked to the ECB.
The ECB's influence has become second to only the Federal
Reserve in influencing transactions and markets abroad. Over $2
trillion in international bonds -- debt securities sold outside of
the issuer's home country -- are denominated in euros, for
instance.
Then there are the central banks in Africa and countries that
border the eurozone whose currencies either track or are hugely
influenced by the euro, meaning they often have to mirror what the
ECB does.
That has left large swaths of Europe with low rates even as
other countries, including the U.S. and Canada, increase
theirs.
Analysts predict the ECB will announce on Thursday that it will
begin tapering its bond purchases, a move that will also hint at
when it will start raising rates.
"The biggest factor for these places is the strength of the
euro," said Piotr Matys, emerging market foreign exchange
strategist at Rabobank, "We'll be watching closely how the currency
reacts; that will set the tone for all these other markets."
When it comes to raising rates, central banks in many countries
appear to be waiting for the ECB to move first.
Over much of Eastern Europe, interest rates are still at
post-financial crisis lows. Hungary even has negative interest
rates, the only emerging-market country in the world to do so.
Even nations with stronger economic growth than the eurozone
have had to resist raising interest rates. Raising them would
likely boost their currency against the euro, making their goods
less competitive while importing the eurozone's low inflation.
Switzerland's economy has grown by around 11% in real terms
since the beginning of 2008, compared to just 4% for the eurozone.
But at minus 0.75% the Swiss National Bank's deposit rate is even
lower than in the ECB's minus 0.4% rate.
"The SNB won't act for as long as the ECB doesn't act, they just
don't want a strong Swiss franc," said Christophe Donay, head of
macro research and asset allocation at Pictet Wealth
Management.
A strong Swiss franc has helped to hold down inflation for
years, complicating the job for the country's central bankers.
Low inflation in the eurozone means muted price gains in its
imports, keeping inflation lower in the non-euro countries that buy
them. A rate increase would likely strengthen their currencies,
encouraging even more imports from the monetary union, and putting
even more downward pressure on inflation.
To be sure, many analysts believe investors have already priced
in what the ECB will do on Thursday.
But for some, signals of tighter ECB monetary policy would offer
an opening to make bullish bets on Eastern European currencies,
like the Polish zloty. That is because as the ECB tightens policy
it will boost the euro, dragging the currencies that track it
higher, they say.
In debt markets, Marcin Kujawski, emerging Europe economist at
Nomura, believes Romania is the most exposed to tapering from the
ECB.
"About half of their debt is foreign currency-denominated,
mostly in euros, and about half is owned by nonresidents," he
said.
When a country issues debt in a foreign currency, it is exposed
to any appreciation in its value. Repaying investors in euros will
cost an increasing amount of Romanian leu if the rollback of ECB
bond-buying drives the euro higher.
In 2016, emerging market issuers around the world sold 121 bonds
denominated in euros, more than at any time since 1999, the single
currency's first year. Mexican oil giant Pemex issued the largest
ever emerging market euro-denominated bond, with a EUR4.25 billion
issue in February.
For 14 countries in Africa, the link with the euro is even
tighter.
There are two monetary unions that peg their currencies -- the
central and west African franc -- to the euro. Both have their own
central banks and interest rates that move independently of the
ECB, but shifts in the euro's value have an economic knock-on
effect.
When the ECB introduced negative interest rates and started
buying bonds, between March 2014 and March 2015, the euro fell from
around $1.39 to as low as $1.05 against the dollar. That offered a
lift to countries using the African francs, which followed the euro
lower making their exports more competitive. But if the euro rises
as the ECB tightens policy, that would have the opposite
affect.
"They appreciate against the dollar when the euro does, and that
raises questions about the impact on their economies," said Victor
Lopes, senior economist covering sub-Saharan Africa at Standard
Chartered.
Write to Mike Bird at Mike.Bird@wsj.com
(END) Dow Jones Newswires
October 22, 2017 07:14 ET (11:14 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.