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Czech Interest-Rate Cut May Hurt Economy Through Koruna, Zamrazilova Says

A further reduction in interest rates wouldn’t help the Czech economy as a weaker koruna threatens to push inflation outside the central bank’s target range, board member Eva Zamrazilova said.

The current weaker exchange rate of the Czech koruna may be a result of a policy that has been too loose in the past two years, Zamrazilova said in a Dec. 12 interview. She voted for a rate increase at eight meetings between September 2010 and August 2011 until voting for unchanged credit costs as Europe’s debt crisis escalated.

“At present, we need to think whether the development with the koruna isn’t the factor that may push inflation outside the target corridor,” Zamrazilova said, referring to the target range of 1 percent to 3 percent. “A reduction of interest rates in the Czech Republic can’t influence demand in our main trading partners, and I don’t consider this to be a step that could lead to anything positive in the Czech economy.”

The Ceska Narodni Banka in Prague has left the two-week repurchase rate unchanged at a record-low 0.75 percent since May 2010, a quarter-point less than the European Central Bank’s main rate. The bank will weigh a worsening economic performance against accelerating inflation when deciding on monetary policy at the final meeting of the year on Dec. 21.

Accelerating Inflation

The headline inflation rate rose to a 35-month high of 2.5 percent in November, mainly due to food costs. Monetary-policy inflation, which is price growth stripped of the primary impact of increases in indirect taxes, was also 2.5 percent.

The koruna has lost 3.7 percent to the euro so far this quarter, the third-worst performance among 25 emerging-market currencies tracked by Bloomberg. The koruna reversed losses today and traded 0.2 percent stronger at 25.619 to the euro as of 3:34 p.m. in Prague. The central bank forecast an average exchange rate of 24.8 for the fourth quarter of the year.

The Czech economy contracted in the third quarter from the previous three months for the first time since a 2009 recession as the debt crisis damped demand for the country’s exports and government spending cuts curbed household spending. The slowdown mirrors the economic situation in many European countries where central banks are holding rates as they assess the effect of the credit crunch on their economies.

The Czech central bank has said the koruna’s moves are important for future decisions on interest rates as a firming currency tames inflationary pressures and tightens monetary conditions, while its weakening makes imports more expensive.

Weakening Currency

“Currency developments become important to me at the time when I think that the deviation of the exchange rate from the forecast becomes a factor influencing inflation and inflation expectations, and I think this may already be the case at this moment,” Zamrazilova said, without referring to a specific exchange rate.

Czech economic growth depends on demand for products including Skoda Auto AS vehicles and other car parts from the EU. The bloc buys about 80 percent of the country’s exports, with Germany accounting for a third. Government measures to cut the budget deficit below the European Union’s limit of 3 percent of GDP by 2013 are damping domestic demand as well.

The central bank doesn’t have “too much” room to cut interest rates further, the CTK newswire cited Governor Miroslav Singer as saying in an interview on Dec. 12.

Base Scenario

The central bank’s base scenario sees the koruna gaining next year, with the average exchange rate at 23.1 to the euro. The bank also prepared an alternative scenario which sees a “sharp slowdown” in the euro area’s economic growth next year. Under this outlook, the koruna would be weaker, averaging 24.2 per euro, and market interest rates would stay stable.

The central bank board agreed that the “alternative scenario provided a more realistic picture of the future than the baseline scenario,” according to the minutes from the bank’s Nov. 3 policy meeting.

“I’ve been thinking for a year and a half as to whether rates shouldn’t be higher, and I’m constantly thinking about it,” Zamrazilova said. “Only at the time of an escalating crisis in the euro zone did I think it wouldn’t be appropriate to take measures in the tightening direction.”

To contact the reporter on this story: Peter Laca in Prague at placa@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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