Vol surge expected from Eastern Europe

Political events in countries slated to join the European Union and the euro are set to trigger a wave of foreign exchange volatility in emerging European countries, market participants said.

This could spell good news for investors and banks seeking volatile markets to trade outside the relatively static G7 currencies.

Since the European Council concluded negotiations with the 12 accession countries in December, many of the convergence issues have already been priced into the market, analysts said. "Although December was successful, the process is not finished and there will be more volatility," said Lena Komileva, Europe, Middle East and Africa economist at Prebon Yamane in London. If political events add uncertainty to this process, a correction will take place, particularly in the more developed foreign exchange markets of Hungary, Poland and the Czech Republic.

"It is already a given from our experience in the mid-90s that markets are going to become more volatile in the run-up to EU accession," Komileva told RiskNews’ sister publication FX Week. "At a time when risk aversion is bringing investors into safe-haven assets, these markets are probably going to outperform, and that will provoke volatility."

The most serious political ructions have occurred in Poland and the Czech Republic. Last week, Polish prime minister, Leszek Miller, expelled the Peasant’s Party from the coalition government after the party, which is popular with poorer citizens and farmers, voted against a tax bill.

"Poland now has a minority government," said Marios Maratheftis, economist at Standard Chartered Bank in London. "The risk now is whether it will be able to carry out any reforms – which are necessary for euro entry. It is possible that this will not happen and they will not be able to proceed with euro entry."

In the Czech Republic, the three-party coalition government faces a potential vote of no confidence on March 11. It holds 101 of the 200 seats in the parliament, so if just one government MP votes against the three-party team, the government will collapse.

Another problem facing the markets is the growing sense of euro scepticism among opposition politicians in the accession countries. For accession to continue, sceptical electorates must be won over.

"Recent polls show a comfortable enough margin for a yes vote, but scepticism is high across first-wave EU accession countries," said Komileva. "One EU commissioner said selling the EU to local electorates is like trying to sell an old car that costs too much to run and is expensive."

There are precedents for unsuccessful EMU referendums. In September 2000, after a lengthy and expensive campaign by the Danish government, Denmark’s voters rejected EMU membership.

Meanwhile, Hungary is posing problems. Last month, the central bank was forced to wade into the market and spend €6 billion to halt forint appreciation amid a sudden surge in volatility. The intervention was relatively successful, but analysts said, it represented a short-term fix.

In January and February alone, Hungary spent around 25% of its budget deficit target upping the chances that it will overshoot the target. "It means monetary policy will need to do the work on inflation because it seems the government is unable to control its spending," said StanChart’s Maratheftis. "Once inflation is in order, they will be able to relax interest rates, then we will see more funds rushing into Hungary."