Traders Calling Bluff on Intervention Threat as Koruna Gains

Czech Central Bank Governor Miroslav Singer
Miroslav Singer, governor of the Czech central bank. Photographer: Vladimir Weiss/Bloomberg

Traders are ignoring Czech National Bank Governor Miroslav Singer’s threat to intervene for the first time in a decade to weaken the koruna and revive the economy as the currency extends the biggest rally in emerging markets after Hungary’s forint.

The koruna has strengthened 0.3 percent to the euro since Singer’s comments on Sept. 27 and is up 1 percent this month, second only to the forint among major developing-nation peers tracked by Bloomberg. Options traders are paying on average in October 1.7 percentage points more for the right to sell the koruna rather than to buy it in three months, the lowest premium since August 2011, so-called risk-reversal rates show.

After cutting borrowing costs to a record 0.25 percent, half a point below the euro area, Singer said he may use “the exchange-rate channel” next to relax monetary conditions. The Czech economy, where exports account for 75 percent of output and are dependent on demand from the European Union, shrank 0.2 percent in April to June, its third quarterly contraction.

“The koruna is more likely to test stronger levels as the market will try to provoke the CNB,” Jan Vejmelek, chief economist at Komercni Banka AS in Prague, said in an Oct. 17 phone interview. The Czech economy’s return to modest growth next year while the euro area continues to struggle also gives the koruna “a relative edge,” he said.

Trade Surplus

The Czech currency weakened 0.1 percent today to 24.892 per euro by 4:52 p.m. in Prague. Falling interest rates and demand from foreign investors pushed the yield on benchmark 2017 koruna-denominated notes to a record-low 1.05 percent last week, data compiled by Bloomberg show. It stood at 1.06 percent today.

Koruna gains have been fueled by the country’s trade surplus and cuts in the budget deficit that helped make Czech bonds a “safe haven” in emerging Europe, according to a report by Moody’s Investors Service from Oct. 15.

Rate setters in emerging Europe are easing policies along with the European Central Bank to address an economic slowdown triggered by the euro area’s sovereign-debt crisis.

The CNB seeks to prevent inflation from slowing to less than the 2 percent target as cuts in household spending helped fuel a second recession in three years. Policy makers have lowered the benchmark two-week repurchase rate by a total of 50 basis points, or 0.5 percentage point, so far this year.

The premium traders are paying to insure against the koruna’s weakening has shrunk from as much as 2.6 percentage points in June, the risk-reversal data show.

‘Little Room’

“We can further relax monetary policy in the little room we have,” Singer told reporters in Warsaw on Oct. 18. “The next tool in line will be the exchange-rate channel.”

Unlike the Swiss central bank, which set a cap last year on the franc to stop its gains from hurting the country’s economy, policy makers in Prague haven’t indicated any exchange rate at which they may start to sell the koruna.

“The CNB targets inflation, not the exchange rate,” Marek Petrus, the bank’s spokesman, said by phone Oct 17. “It’s up to the central bank’s board to assess whether or not further policy loosening is needed.”

The central bank last stepped into the market to weaken the koruna 10 years ago, Singer said on Sept. 18. The bank bought $438 million and 444 million euros ($579 million) in September 2002, records on its website show. The intervention followed a 9.5 percent rally that year, with koruna touching the then strongest on record of 28.9 per euro two months earlier.

‘Immediate Action’

The Czech currency had appreciated 2.3 percent against the euro in the third quarter before Singer’s Sept. 27 comments, the best performance for the period after the Chilean peso and India’s rupee among major emerging markets. The koruna added 0.6 percent last week, the most among the peer group, touching the strongest level in a month at 24.7 on Oct. 17.

“If sentiment keeps positive around the euro area, nothing can stop the koruna from strengthening,” Aurelija Augulyte, a Copenhagen-based emerging markets strategist at Nordea Bank AB, said in e-mailed comments to Bloomberg today. “Levels around 24 would get them worried. But I don’t think they will intervene.”

The CNB may sell the koruna should the currency strengthen “significantly beyond” 24.50, the recession deepen and deflation pressure increase, Komercni Banka’s Vejmelek said.

“As long as the appreciation process doesn’t accelerate, the CNB will stay on the sidelines,” Peter Schottmueller, who helps manage the equivalent of $5.3 billion in emerging-market debt, including Czech local-currency bonds, at Deka Investment GmbH in Frankfurt, said in e-mailed comments on Oct. 19. Singer’s words “don’t imply immediate action,” he said.

‘No Choice’

The Czech economy is suffering from weaker domestic demand after the government cut investments and raised sales taxes to trim the budget deficit. Export growth was the slowest since the start of 2010 in the second quarter as the euro area’s crisis curbed purchases of electronic goods and cars. The 27-nation EU buys 80 percent of Czech exports, including cars from Volkswagen AG’s unit, Skoda Auto AS.

While consumer prices fell for three consecutive months through September on a monthly basis, annual inflation has remained above 3 percent this year because of factors outside of monetary policy influence, including increases in tax rates and commodity prices, according to the central bank.

The koruna will probably weaken to 25 per euro by Dec. 31, or a 0.6 percent retreat, before rebounding to 24.5 per euro in September 2013, according to the median forecast of 18 analysts in a Bloomberg survey.

The CNB “has no other real option than to weaken the currency given the fact that the fiscal policy is tight and the interest rates are now near zero,” Murat Toprak, chief currency strategist for emerging Europe, the Middle East and Africa at HSBC Holdings Plc in London, said on Oct. 5. “There is no other choice but to intervene and ultimately help the economy.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE