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The zloty weakened during trading yesterday after the core inflation reading for August came in softer than expected at 0.7y/y (market expectation: 0.8%). This is a significant reading in our view: a number of regional central banks had forewarned that the impulse of inflation acceleration around the euro zone could fade after the summer.
Although battles between Poland and the EU regarding Poland’s perceived rule-of-law infringements will persist, these ultimately constitute political noise without the credible threat of Article 7 sanctions materializing. Against a favourable backdrop of Eurozone recovery and slow monetary policy normalization from the ECB and the Fed, PLN may strengthen modestly over the coming quarters. We forecast the first hike in Poland to occur in July 2018 (with the NBP raising rates before the ECB), as Polish officials respond to the recovery of domestic demand and overheating in the labour market.
On a separate note, the EC yesterday launched a second infringement procedure against Poland on its laws on the system of common courts as the government's previous responses were not adequate. This could have been an additional factor against the zloty yesterday and has more potential to move the currency in the medium-term.
The major driving forces: The sustainable and robust macro-economic performance will likely lend further resilience to PLN. Hawkish rhetoric from some members of the MPC concerned about persistent negative real interest rates can accelerate expectations of policy rate hikes.
Risks: Sharp increases in EUR rates and UST yields can impair PLN. Further controversial measures and proposals from the government can weigh on investor sentiment.
At spot ref: 4.2790, we advocate entering a new EURPLN 1m2m diagonal put spread (4.3185/4.2625). The underlying spot FX trend and IVs are favorable to write ITM puts.
