Czech Auction Yield Tumbles to Record Low as Zero Rates Loom
The Czech government’s funding costs fell to an all-time low for the fifth consecutive bond auction as the koruna’s appreciation to the strongest in four months added to expectations for interest-rate cuts to zero.
The country sold 4.7 billion koruna ($238 million) of fixed-rate debt maturing in 2021 and floating-rate bonds due 2017, data compiled by Bloomberg shows. Investors bid for more than twice the amount raised. The average accepted yield on the nine-year securities fell to 2.14 percent, the lowest ever, compared with 2.32 percent at their last sale on July 18.
Slowing global growth and the koruna’s gains are dimming prospects for the Czech export-led economy after three quarters of contraction. The Czech National Bank, which reduced its main rate to a record-low 0.5 percent in June, may decrease its forecast for gross domestic product, and rate cuts toward zero cannot be ruled out, board member Lubomir Lizal said on Aug. 19.
“Czech rates may fall to zero or even negative, especially should the koruna stay at the current strong levels,” Jaromir Sindel, a Prague-based economist at Citigroup Inc., said in a telephone interview yesterday. The bank forecasts the benchmark rate will be reduced to 0.05 percent by yearend, he said. “Before introducing negative rates, the CNB would probably consider intervening against the koruna.”
Forward-rate agreements, or FRAs, show investors expect the CNB to cut the benchmark -- already below the European Central Bank’s 0.75 percent -- to zero by May. Nine-month FRAs fell to 50 basis points, or 0.50 percentage point, less than the Prague interbank offered rate this week, the strongest bet on policy easing since February 2009, data compiled by Bloomberg show.
The Czech currency has gained 2.1 percent against the euro this month, the second-most among major emerging-market peers tracked by Bloomberg. Its appreciation hurts revenue from Czech exports, which account for about 75 percent of GDP, according to statistics office data. The CNB may counter further economic weakness with zero or negative rates and may act to weaken the koruna by about 10 percent, Mai Doan, an analyst with Bank of America Merrill Lynch in London, wrote in an Aug. 6 report.
The koruna weakened 0.3 percent today to 24.808 per euro by 4:29 p.m. in Prague, after a 0.9 percent gain in the previous four sessions to the strongest since April on closing basis.
Policy makers were split at their last meeting on Aug. 2 in assessing inflation risks, voting four-to-two to hold rates. The “delay” in monetary easing raises the risk that the central bank will have to adopt more radical measures to avert deflation, Vice Governor Vladimir Tomsik said two weeks ago.
Czech bonds are luring investors with higher credit ratings than for most euro members, public debt at half the euro-area average and Prime Minister Petr Necas’s pledge to lower the budget deficit to below the European Union’s 3 percent of GDP limit next year for the first time since 2008.
Moody’s Investors Service rates the Czech Republic at its fifth-highest grade of A1, four steps above Italy and five above Spain. The cost of insuring the debt with credit default swaps is the lowest in emerging Europe except Estonia and lower than in Aaa-rated France. Improving perceptions of creditworthiness have cut the Czech default swaps by 63 basis points this year to 111 today, according to data compiled by Bloomberg. That compares with a 44 basis-point drop to 59 in Germany.
The swaps pay the buyer face value in exchange for the underlying securities or cash equivalent if the issuer fails to comply with debt agreements.
“Czech debt is trading more or less as a core eurozone credit,” Nicholas Spiro, managing director at Spiro Sovereign Strategy in London, wrote in an e-mail to Bloomberg News after the sale. “In the realm of investor perceptions, this is pretty much as safe as it gets for a continental European country.”
Deficit cuts and the fact that the Czech Republic does not share the burden of rescuing the most-indebted euro nations is poised to lower the extra cost of its default swaps to 20 basis points above Germany, Felix Herrmann, an analyst for emerging markets at DZ Bank AG in Frankfurt, wrote in an Aug. 27 report.
“The Czech government is still eager to pull the budget deficit below 3 percent next year and we are optimistic that this goal will be reached,” Herrmann said. “The Czech Republic will certainly continue benefiting from the fact that it is not a euro-zone member” while planned measures to stem the debt crisis may “weigh negatively on the German solvency,” he said.
The Czech bond rally increases the risk that investors will avoid the securities because the yields are already reflecting expectations for additional interest-rate cuts and “there is not much space for further yield contraction,” said Martin Lobotka, an economist at Ceska Sporitelna AS in Prague.
“Czech yields are more likely to rise than stay flat or decline further” and “we see existing levels as attractive for taking profit from the bonds’ holdings,” Lobotka wrote in a report to clients dated Aug. 27. “It is also unclear whether the CNB will really go all the way to zero.”
Czech public debt is equivalent to 44 percent of GDP, below Poland at 55 percent, Hungary at 79 percent and the euro area at 92 percent, according to European Commission estimates for 2012.
Demand for government bonds is helped by deposits exceeding loans at Czech banks and laws barring pension funds from riskier assets. Czech lenders have boosted capital reserves since 2008 to “ample” levels and are “resilient against substantial shocks,” the International Monetary Fund said on July 17.
“The country has a stable and moderate fiscal deficit and low debt-to-GDP, while the banking sector is very strong,” said Demetrios Efstathiou and Phoenix Kalen, London-based strategists at Royal Bank of Scotland Group Plc, in an Aug. 24 report. “We expect long-end bond yields to continue to drop.”
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