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Europe’s Next Big Currency Opportunity Just Got a Lot Closer

Updated on
  • Czech inflation accelerates to highest in over three years
  • Price growth keeps central bank on track to exit koruna cap

After being held back by the central bank for three years, the Czech koruna is preparing for its final leap to freedom.

Following Switzerland’s shock move to ditch its exchange-rate cap two years ago and six months after the pound’s Brexit-prompted plunge, the koruna is the next currency in Europe with a date for change. The unprecedented spate of sluggish price growth that prompted the central bank to slap a lid on the currency is over, after the Czech inflation rate almost doubled to 1.5 percent in November, the highest level in more than three years.

Friday’s reading exceeded the 1.3 percent forecast in the Bloomberg survey, and it’s the first time the indicator has returned to the central bank’s 1 percent to 3 percent tolerance band since the end of 2013 when policy makers first blocked koruna appreciation. It was also higher than the regulator’s 1 percent prediction for November, solidifying the scenario forecast by rate setters that they may cut the currency loose in around mid-2017. Price growth may exceed the central bank’s 2 percent target in the first quarter, according to ING Groep NV, putting an end to the regulator’s habit of pushing back the date of when it will pull the trigger.

“The koruna will soon become an exciting trade again, after all those years of minimal action,” said Petr Krpata, chief currency and rates strategist for Europe, the Middle East and Africa at ING in London. “Two-way euro-koruna moves will be considerable during the first weeks after the exit, before stabilizing toward a natural trading path, yet with structurally higher volatility compared to past years.”

Rising wages, an improving economic outlook and the prospect of more expensive oil are all translating into faster price growth. As it nears its quest for higher inflation, the central bank is preparing its strategy to end the non-standard policy stance. Echoing moves by other global central banks, the monetary authority has boosted its balance sheet by about 30 billion euros ($32 billion) to keep the koruna from gaining beyond 27 per euro.

While the inflation trend supports arguments for the bank to leave the currency regime next year, the fate of the European Central Bank’s quantitative easing could potentially obscure the timing. The ECB extended its quantitative easing program until the end of 2017 on Thursday while reducing the monthly pace of purchases by a quarter to 60 billion euros starting in April. That differs from Czech policy makers’ current forecast, which assumes the bond-buying program will end in March.

Some Czech rate setters have cautioned that prolonged ECB stimulus may complicate or delay the exit from the koruna cap, but Governor Jiri Rusnok said he sees domestic economic developments as the key factor in his policy considerations.

The upcoming demise of the cap has put the spotlight on the koruna, with investors expecting appreciation to keep it near the limit. The currency has moved in a narrow range for months, trading 0.1 percent stronger at 27.027 against the euro at 1:40 p.m. in Prague. Future contracts put the koruna at 26.766 to the euro in 12 months’ time. Policy makers have said they don’t expect sharp gains after they remove the ceiling and are ready to prevent excessive swings with ad-hoc interventions and potentially even negative rates.

“Inflation alone isn’t the only recent news that shows a maturing economic cycle and gradually strengthening inflation pressures,” Jan Bures, an analyst at bank CSOB AS, said by e-mail. “Positive surprises for the CNB are also coming in the form of a further decline unemployment and accelerating wages. Therefore, it seems that domestic factors are clearly supporting the planned end of interventions next year.”

The central bank considers the November inflation data as an “inflationary risk” to its current forecast, according to which price growth will “slightly exceed” the target at around the end of 2017, it said in a statement. The regulator added that its forecast assumes the koruna cap will remain in place until the middle of next year.

Read more: Central bank debates how and when to end koruna cap

The central bank may feel more comfortable about the exit timing after the government engaged in a drive to raise salaries by boosting the minimum wage and pushing some private employers to increase their workers’ pay.

The average real monthly wage increased 4 percent in the third quarter, accelerating from 3.7 percent in the previous three months and exceeding analysts’ estimates of 3.6 percent. Annual wage increases in the first three quarters have put this year on track for the biggest gains since 2007, before the global economic crisis.

Czech unemployment has been steadily declining and the jobless rate dropped to an eight-year low of 4.9 percent in November, another sign that household purchasing power is becoming more robust as companies pay more to compete for workers.

— With assistance by Radoslav Tomek

(Updates with central bank inflation comments in 10th paragraph.)
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