Betting on Koruna Cap Exit Seen Pointless on Weak Inflation

  • Most analysts see cap scrapped in October 2016 or later
  • Some economists expect central bank to impose negative rates

Betting that the Czech central bank will move forward scrapping its currency cap regime will be futile for at least another year as inflation remains stuck below target, a Bloomberg survey of analysts showed.

Rate setters in Prague won’t let the koruna strengthen beyond about 27 per euro before October next year, according to 12 of 19 economists in the poll, including seven who expected the policy to be extended into 2017. The remaining respondents predicted the cap will be ditched in the second or third quarter of 2016, while the central bank has pledged to keep a combination of near-zero rates and the limit on currency gains until at least July next year.

The Czech National Bank will review its monetary policy Thursday, with board members set to discuss downward risks to the inflation outlook as the country’s fastest economic expansion in eight years fails to spur price growth. The recovery has boosted demand for the koruna, forcing the central bank to resume sales of the currency in July in the first interventions since the cap was imposed almost two years ago.

“Deflation risks are rising again in central and eastern Europe, so the risk is tilted toward ending the floor later, not sooner,” said Win Thin, global head of emerging-market strategy at Brown Brothers Harriman & Co. in New York. The interventions are “pretty costless” for the CNB, allowing it to defend the limit until the fourth quarter of next year, Thin said.

Policy makers have pledged to defend the cap with unlimited interventions because falling commodity prices are hampering their efforts to lift inflation to the 2 percent target from 0.3 percent last month. ING Groep NV estimates the central bank sold about 90 billion koruna ($3.8 billion) in August to stop the currency from gaining, triple the amount the regulator reported for July.

The koruna was little changed on Wednesday at 27.11 per euro as of 4:35 p.m. in Prague. It’s 1.1 percent stronger against the euro over the past six months, the best performance among 31 major currencies tracked by Bloomberg.

Board member Lubomir Lizal pointed to disinflationary risks last week and warned that more policy easing may be needed to achieve the price-growth target. Jiri Rusnok, another rate setter and the top candidate to replace Governor Miroslav Singer next year, added to the message on Sept. 15 by saying he couldn’t rule out using negative interest rates to deliver more monetary stimulus.

While none of the 19 analysts in the poll expected the CNB to push the koruna limit to a weaker level, three forecast it would cut the main deposit rate below zero from 0.05 percent.

“Negative interest rates could function both as a substitute for and a
complement to the currency floor,” Wolf-Fabian Hungerland, an economist at Joh Berenberg Gossler & Company KG in Hamburg, said by e-mail Sept. 18. He expects an exit from the koruna limit in the second quarter of next year.

The group of analysts that didn’t forecast sub-zero rates included Anna Tokar and Gabor Ambrus at Royal Bank of Scotland Group Plc in London, who said the CNB was more likely to extend its commitment to keep the koruna cap into 2017.

“We expect the CNB to up its dovish tone,” Tokar and Ambrus said in a Sept. 21 report to clients. “The need for looser monetary conditions in the Czech Republic has increased, with extension of the use of the floor beyond the second half of 2016 becoming increasingly likely and an early removal of the floor increasingly unlikely.”

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