Czech Central Bank Keeps Rates Unchanged as Koruna Weakens

The Czech central bank left interest rates unchanged for a 13th meeting as a weaker koruna keeps policy makers from lowering borrowing costs as signaled in the bank’s latest forecast.

The bank board voted 7-0 today in favor of no change to rates as it weighed a worsening economic outlook against accelerating inflation at the final meeting of the year. The decision matched the forecasts of all 21 analysts in a Bloomberg survey. The Ceska Narodni Banka has kept the two-week repurchase rate at a record-low 0.75 percent since May 2010, a quarter-point less than the European Central Bank’s main rate.

“Although we see the risks as slightly pro-inflationary, it doesn’t mean that we cannot imagine that the next move may be in any direction,” Governor Miroslav Singer told reporters in Prague. “At this moment, it appears more likely that the move will be upward though this doesn’t necessarily have to happen any time soon.”

The bank has said the koruna’s moves are important for future rate decisions as a firming currency tames inflationary pressures and tightens monetary conditions, while its weakening makes imports more expensive. The koruna has lost 3.6 percent to the euro this quarter, the second-worst performance among 25 emerging-market currencies tracked by Bloomberg.

Weaker Koruna

The koruna weakened 0.2 percent to trade at 25.613 to the euro as of 3:08 p.m. in Prague. The central bank forecast an average exchange rate of 24.8 for the fourth quarter of the year.

A weaker koruna and faster-than-forecast inflation at the moment are pro-inflationary risks, Singer said. Developments in the Czech and euro-area economies show that the bank’s alternative scenario is materializing, he said.

The central bank’s base forecast, published Nov. 3, sees the koruna gaining next year, with the average exchange rate at 23.1 to the euro. It assumes a decline in market interest rates by the end of the year.

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.

Pared Bets

Investors in interest-rate derivatives pared bets that the Czech central bank will reduce borrowing costs as inflation accelerated. Forward-rate agreements fixing three-month interest costs in six months rose to 1.02 percent today, from 0.98 percent on Nov. 4 after the last rate decision. The Prague interbank offered rate was 1.17 percent today.

The inflation rate rose to a 35-month high of 2.5 percent in November, mainly on food costs. Inflation relevant for monetary policy, which is price growth stripped of the primary impact of increases in indirect taxes, was also 2.5 percent, more than the central bank’s target of 2 percent. The economy shrank 0.1 percent in the third quarter from the previous three months, the first quarterly contraction since a 2009 recession.

Government austerity measures are curbing domestic demand, with household consumption falling 0.5 percent in the July-September period and state spending declining 0.4 percent, according to statistics office data. Czech exports also weakened as the euro-area’s debt crisis curbed demand for products including cars, auto parts and electronics goods.

Export-Driven Economy

Czech growth depends on demand for its products from the EU as the bloc buys about 80 percent of the country’s exports, with Germany accounting for a third. The slowdown mirrors the situation in many European countries where central banks are assessing the effects of the credit crunch on their economies.

“Given the expected recession in the euro area and the Czech Republic, and an absence of demand driven inflationary pressures, we see room for a reduction in the main rate to 0.5 percent in the first quarter of next year,” Vaclav France, an analyst at Raiffeisenbank AS in Prague, said after the decision.

Hungary increased the European Union’s highest benchmark interest rate by half a percentage point to 7 percent yesterday after the trading bloc and the International Monetary Fund suspended talks on a bailout, threatening to pressure local assets. Poland’s monetary authority has kept the benchmark rate at 4.5 percent since July after raising borrowing costs by a combined 1 percentage point in the first half of the year.

While the koruna will probably be an important factor for the central bank’s decision-making, the weight of domestic demand is likely to prevail, Jaromir Sindel, Citigroup’s Inc. Chief Economist for the Czech Republic and Slovakia in Prague, said in a note to clients.

“All in all, the CNB has to manage its koruna dilemma,” Sindel said. “We expect some form of verbal fine-tuning from the CNB to continue, that is sounding hawkish to limit koruna weakness, but not too much to provide relief for exporters.”

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