The Polish zloty has risen after the country's president vetoed controversial legal proposals.
The downside risk to the Polish zloty (PLN) has materially decreased after the country's president vetoed controversial proposals which gave the ruling party control over judicial appointments. The move, by President Andrzej Duda, was a surprise; he's blocked two out of three measures which would have given the Polish justice minister greater powers in choosing senior judges. The proposals had prompted street protests and fierce criticism from the European Commission.
The zloty may trade with a persistent degree of political uncertainty risk premium.
However, the move could lead to a constitutional showdown between the ruling party (the PiS) and the president. The PLN rallied this Monday but did not fully recover Friday's losses, which were driven by political uncertainty. Some degree of risk premium is still priced in.
At this point, we estimate EUR/PLN is trading with around 0.5% risk premium and we expect this to remain for the time being. Should the PiS try to push for an imminent passage of a new bill, we expect the scope for PLN downside to be:
Back in early 2016, the political risk premium extremes in EUR/PLN were worth 2%-3.5%. This time around, we would expect, at most, a 2% political risk premium to be built in the currency as the situation is different, with a low probability of a credit rating downgrade and a better macro situation.
The decision is positive for Polish government bonds (POLGB), but given the relative resilience of the local bond market, the scope for a POLGB rally is more limited than for PLN spot, as seen in the price action after the President's news conference. Even if the situation deteriorates, on a relative basis, we expect a repeat of last week’s price action where POLGBs were more resilient than FX. This POLGB resilience stems from the following factors:
All this suggests that POLGBs should be more resilient than the zloty, should negative headline news hit the market again. But it's clear that PLN prospects look better than before the veto earlier this Monday morning.