Franc Ordeal Irks East Europe Holdout Trying Not to Be SwissBy and
Czech central bank faces speculation over timing of cap exit
Hampl emphasizes bank’s credo of transparency in policy
Once dubbed the Switzerland of eastern Europe for its status as a safe haven for investors, the Czech Republic is now tirelessly stressing the difference.
Two years after the Swiss central bank roiled global markets by removing its cap on the franc, its Czech counterpart has explicitly ruled out delivering a similar jolt as it approaches the moment when it can unshackle the koruna following the end of near-zero inflation.
Still dwelling on memories of the shock Swiss announcement and the sharp franc appreciation that followed, the Czech National Bank is striking out on its own in the face of what some investors are calling one of the top currency trades in Europe this year.
“We have been as transparent as possible, always showing the market the potential timing of the exit,” Vice Governor Mojmir Hampl, 41, said in an interview this week when asked about the Swiss experience. “If it were to be a Swiss-style surprise, no one would have any chance whatsoever to be asking these questions” about the timing of the policy change.
The Czechs followed in the footsteps of the Swiss National Bank and intervened heavily by selling their currency to stop it from gaining, with the eastern European regulator’s balance sheet swelling to unprecedented levels. Now the central bank in Prague has to contend with speculation that an unexpected spike in inflation will force it to remove the koruna limit sooner than in mid-2017 as outlined in its forecast.
Bets on koruna appreciation were visible in the derivatives market this month, as twelve-month forwards dropped to 26.51 per euro on Jan. 11 from 26.73 at the end of December. The spot-market exchange rate has been stuck near to the cap level of around 27 per euro for months, and the one-year forward contract has erased its January move, rising to 26.72 on Friday.
“The most notable reflation trade in the region has been a surge in inflows into the Czech Republic,” Morgan Stanley analysts said in a report, estimating that the central bank was forced to buy more than 5 billion euros ($5.3 billion) in the first 10 days of January alone. ING Groep NV said its purchases may have totaled about 4 billion euros in the first week of this month.
The koruna is now “overbought,” according to Lubomir Lizal, one of the two central bank board members whose terms end about two weeks after the next monetary-policy meeting scheduled for Feb. 2. That’s why the currency looks more likely to weaken after the cap is removed than to appreciate, Lizal said in an interview published on the website Euro.cz on Friday.
In explaining the unlimited nature of its intervention policy, the monetary authority has repeatedly said it doesn’t see a risk in an ever-growing pile of reserves, also adding that it has no obligation to contribute any profits to the state budget. But David Vavra, the bank’s former chief forecaster, said policy makers probably weren’t “immune” to the build-up.
“That story is becoming less and less tenable as the balance sheet is exploding,” said Vavra, who is now the managing partner at consulting firm OGResearch, which advises central banks in eastern Europe and Africa. “The balance sheet in relevant measures, both forex reserves relative to currency in circulation and as in percentage of GDP, has surpassed that of China, surpassed that of Japan and it’s nearing that of Switzerland, and in an explosive manner.”
To Hampl, such argument doesn’t hold.
“We have been communicating that there are no conditions on the side of the reserves or the size of the balance sheet that would somehow limit our ability to credibly implement this type of full-fledged foreign-exchange commitment,” he said. “If there were ever any balance-sheet concerns on our side, I don’t believe that we would have even started the exchange-rate commitment.”
The exact date for scrapping the unconventional monetary stimulus isn’t yet set and the ultimate decision will depend on board members’ assessment of the inflation picture, Hampl said. He warned investors that quick koruna gains after the biggest policy reversal in three years are far from guaranteed.
One reason is that there may simply not be enough sellers in the market when those who piled into koruna try to turn a profit on the anticipated appreciation.
“If everybody is trying to buy the euros and exit from those koruna positions, who will be on the other side of the trade if it’s not the central bank?” he said.
— With assistance by Michael Winfrey, Radoslav Tomek, Andrea Dudik, and Craig Stirling