The sale of Polish bonds continues. Such a high 10-year bond yield has not been seen since the collapse of Lehman Brothers in 2008, which started the great financial crisis. In the case of five-year bonds, the profitability is the highest since 2004. This is bad news for the government as it means an increase in debt servicing costs.
The profitability is the product of the bond price and its interest rate (coupon). If the interest rate is fixed – as is the case with most securities sold by the Polish government – and the price falls, then profitability increases. And this is exactly what we have been dealing with for several weeks.
Polish bonds – the highest number since 2008
On Monday afternoon, the yield rose again, in the case of ten-year bonds breaking the psychological barrier of 7%. This is the highest number since October 2008. The profitability of five-year-olds was 7.40 percent, which has not been seen for a generation (previously it was 18 years ago).
Because interest rates are rising
Mateusz Sutowicz, Bank Millennium economist, says that the current situation on the debt market is the product of several factors.
The first is domestic monetary policy. The market expects the Monetary Policy Council to raise interest rates further, according to FRA forward rate agreement valuations, the target level of the NBP reference rate – the main central bank rate – will amount to 7.5 percent. After the May hike, it is 5.25 percent for the time being.
“Another factor is the so-called core markets: US or German bond yields are also growing, which also results from what is happening with monetary policy on a global scale. The pressure from the core markets is also the reason why profitability now has only one direction and it is an upward direction”, says Mateusz Sutowicz to the economy.
The third issue is Polish fiscal policy. According to the economist, the market plays against the government’s greater borrowing needs.
“The budget, however, is not made of rubber and there is a growing belief that borrowing needs will be high, much higher than at present. One may wonder, for example, what additional expenses will be in next year’s budget [in 2023, elections to the parliament are planned – ed.], in addition, further issues of bonds of Bank Gospodarstwa Krajowego are announced, which from time to time perform the function of such a quasi-finance ministry. It all adds up to the picture of the increase in debt servicing costs”, says Mateusz Sutowicz.
Long list of expenses
The scale of tensions in the budget may indeed be large. On the one hand, the government has just ordered a large reduction in income taxes, which, in combination with the previously adopted changes, means a loss of PLN 30 billion in revenues. In addition, the so-called anti-inflationary shield – the Ministry of Finance assumes that it will be in force until the end of the year, although it is formally planned until July. The reductions in indirect tax rates that make up the shield represent a loss of income of 0.8%. GDP this year.
On the other hand, the government is planning additional expenses, such as the 14th retirement pension (in the previous year it cost PLN 10.4 billion), will be forced to incur greater expenditure due to the influx of refugees from Ukraine (PLN 11 billion according to preliminary estimates) and declares an increase in military spending up to 3 percent GDP.
The increase in borrowing needed to finance all this boils down to a greater supply of bonds – and this already causes a decline in their prices on the market, which drives profitability. In the future, it will cause an increase in debt servicing costs: the government, wishing to obtain the same amount of money from the sale of one bond as now, will have to increase its interest rate. So it will pay higher interest to potential creditors.
The Ministry of Finance already estimates that the debt servicing costs will increase to around 2.1%. GDP next year, which means that it will be almost twice as large as in 2021.
Is the market exaggerating?
According to Mateusz Sutowicz, what we are currently observing on the market is also the effect of market reaction: investors usually assume a higher rate hike than it actually amounts to afterwards. This has its advantages and disadvantages: the bad thing is the increase in market interest rates, which is currently happening on the bond market, but also on the interbank market, where WIBOR rates soar. The good thing is that it supports – or at least should support – the zloty exchange rate.
The expert points out that the Monetary Policy Council, did not set the target level of the interest rate, not wanting to tie its hands with it. Which is a good basis for such market behaviour.
“The fact that the Monetary Policy Council, is doing this is right. But it is not good that it is impossible to discover what the Council is guided by when making decisions at subsequent meetings, which leads to surprises and increases uncertainty. Since October 2021, the MPC has acted only twice as expected by the market”, says Sutowicz.
At that time, the Monetary Policy Council, raised interest rates eight times. The last surprise was the decision in May: experts expected a 100bp rate hike due to surprisingly high inflation in April. Once the MPC reacted in this way to the surprising inflation data exactly a month earlier. Meanwhile, the Council raised rates by 75 basis points.