Czechs Play Koruna Hardball With Unlimited Interventions

The Czech central bank’s return to currency interventions after 11 years heralds a push for a weaker koruna to ward off deflation and kick-start the economy.

The koruna sank 4.4 percent to 26.975 per euro yesterday, its biggest-ever drop, after the central bank sold the currency in the market. Governor Miroslav Singer pledged to keep intervening “for as long as needed” to spur inflation, setting a target of “near” 27 per euro, a level last seen in 2009. The koruna was little changed today, while its implied volatility fell to the world’s lowest, along with the Swiss franc.

Central banks from the U.S. Federal Reserve to the Bank of Japan have expanded monetary stimulus beyond interest-rate cuts as the global economy struggles to pick up five years after the onset of the global credit crisis. The Czech National Bank, which has kept interest rates at 0.05 percent for a year, is fighting off an inflation slowdown that’s followed 18 months of recession, the longest on record.

“The central bank signaled willingness to play hardball in its foreign-exchange policy,” Luis Costa, an emerging-market strategist at Citigroup Inc., said by e-mail from London. “For the moment, I believe the ‘ideal level of 27’ will be met.”

Deflation Risk

Koruna traded at 26.966 per euro by 3:59 p.m. in Prague. Investor bets on the size of the koruna’s swings against the euro in the next three months tumbled to 3.60% today from 4.97% yesterday. That is on par with the Swiss franc and the lowest among 34 currencies whose volatility is tracked by Bloomberg.

The European Central Bank lowered its benchmark rate to a record 0.25 percent yesterday, driving the euro down by the most in two years versus the dollar, and President Mario Draghi said the region risked a “prolonged period” of low inflation.

Czech consumer prices, which rose 1 percent in the 12 months through September, may decline at the beginning of 2014, according to Komercni Banka AS forecasts.

That’s worried policy makers, with some raising concerns “about the economy slipping into deflation, which the central bank should be proactive in preventing,” according to the minutes of their last rate-setting meeting.

“It’s clear to us that we are in this for a long time,” Singer told reporters about central bank koruna sales yesterday. “The question is not whether we will end it in 2014, but rather whether it’s going to be enough.”

Swiss Example

Unlike interventions aimed at strengthening the exchange rate, which require sales of foreign currencies that can deplete foreign reserves, the Czech central bank is printing more koruna to drive down its value. The money supply increase may lead to the higher inflation rates that Singer is pursuing.

The CNB probably bought 3 billion euros ($4 billion) to 3.5 billion euros yesterday, David Sykora, chief foreign-exchange trader at CSOB AS in Prague, said in an interview with Mlada Fronta Dnes newspaper published today.

“The power is unlimited,” Guillaume Tresca, a Paris-based strategist at Credit Agricole SA, wrote by e-mail yesterday. “They can theoretically print as much koruna as they want.”

The Swiss National Bank set a cap of 1.20 per euro on the franc in September 2011 to curb inflows and avoid unwanted currency appreciation. The koruna has become the main topic of Czech policy deliberations because its weakening makes imports more expensive and boosts the competitiveness of exports.

’Fairly Strict’

The koruna has lost 9 percent against the euro since Sept. 17, 2012, the day before Singer first signaled the possibility of currency sales. This compares with a 2.3 percent loss for the Polish zloty and 4.6 percent decline for Hungary’s forint.

“It will be a fairly strict target,” Mohammed Kazmi, a London-based analyst at Royal Bank of Scotland Group Plc, wrote by e-mail yesterday. “Given the credibility of the central bank, I think the level will be respected and I don’t expect it to change in the near term.”

The central bank’s board, whose mandate is price stability, voted against the use of interventions in August and September as some members were concerned that rising import prices would further curb domestic demand after three years of government austerity policies. Singer rejected such concerns, saying a weaker currency “will obviously strengthen gross domestic product in a short period.”

With koruna sales, consumer prices will rise 2.2 percent by the fourth quarter of 2014, compared with the 1.2 percent inflation that policy makers envisaged without the currency interventions, central bank forecasts published yesterday show.

‘Buying Opportunity’

The depreciation of the koruna achieved by the central bank will boost Czech exports in koruna terms by 2 percent to 3 percent in six months, CTK newswire reported yesterday, citing Jiri Grund, head of the country’s Association of Exporters.

“The CNB decision came at the right time,” Grund told CTK. “It’s a forceful and bold step that should help Czech exporters and the whole economy.”

Speculation that a weaker koruna will boost the economy and help improve corporate earnings sent the Prague’s PX equity index up 1.3 percent yesterday, the third-best performance among 94 major indexes tracked by Bloomberg. The gauge fell 2.1 percent today, retreating from its highest since Jan. 18.

Gross domestic product will shrink 0.9 percent this year, less than the 1.5 percent contraction previously predicted, the central bank said yesterday. The economy will grow 1.5 percent in 2014, compared with an earlier 2.1 percent projection, according to its forecasts.

“This is a good buying opportunity for Czech stocks as the lower koruna should help Czech exports and therefore improve GDP growth,” Carsten Hesse and Mateusz Zawada, London-based analysts at Wood & Co., wrote in a report to clients yesterday.

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