The Czech National Bank has scrapped a longstanding cap on the koruna’s strength, highlighting how the rise in inflation across the region is forcing central banks to overhaul policy.
The koruna climbed almost 2 per cent against the euro after the central bank’s announcement on Thursday, with the single currency falling below the Kč27 mark for the first time since the limit was imposed in November 2013.
While trading volumes were said to be 50 to 100 times higher than typical in the minutes after the CNB released its decision, the koruna’s advance was far from disorderly and suggests the central bank has managed market expectations well.
“We think they are looking for a monetary tightening here and so want a currency rally, if not they will have to start hiking rates later in the year,” noted analysts at Nomura.
The Czech economy has been benefiting, like others in central Europe, from a signs of an upturn in the eurozone, especially in Germany — which accounts for the bulk of its exports. Falling unemployment — the Czech jobless rate is among the lowest in the EU — has also boosted consumer demand.
Erste Group, the Austrian bank, forecast that Czech growth would accelerate to about 2.7 per cent this year, up from 2.3 per cent last year, helped by both foreign and domestic demand.
In a statement, the central bank made clear it was prepared to prevent an excessive rally in the currency and added that it “did not discuss” tweaking interest rates. The koruna was up 1.7 per cent at Kč26.58 in late trading in London.
The cap was initially imposed in an effort to deflect deflation; with interest rates on the floor and no desire to cut them below zero, the central bank was left with few other options. Keeping the currency relatively weak also helped to support import prices.
While the timing of its removal — dubbed Czexit by market observers — was something of a surprise, the central bank was widely expected to remove the policy before the middle of the year.
Data on surging official reserves had shown that the CNB was fighting an intense battle to keep a lid on the koruna in the face of large speculative inflows. Analysts said that battle had ramped up sharply of late, with the central bank buying around €7.5bn in the last 10 days — a huge sum for a small economy.
“On Wednesday and Thursday last week, the intervention was huge,” said Petr Krpata, an analyst at bank ING. “For the whole of March, it was around €19bn. Huge.” Reserves now stand at around 60 per cent of annual gross domestic product.
Mr Krpata said he thought the central bank made “a mistake” in committing to holding the floor beyond the first quarter with inflation running above the target level, “but it did the next best thing in exiting as soon as possible afterwards”. He thinks the central bank would allow the euro to fall to around Kč25 from here.
Analysts and investors are now keeping a close eye on the debt market for signs of how hedge funds get out of their bets on the koruna. “The interesting thing now is how the huge speculative positioning is unwound,” said Paul McNamara, an emerging-markets investment director at GAM in London.
Funds piled into Czech debt in anticipation of the move, but the debt has now dropped substantially. Yields on the country’s two-year debt climbed by over 0.2 percentage points yesterday, but they still remain in negative territory.