Photographer: Martin Divisek/Bloomberg

Czechs Dust Off Old Tools After Swiss-Style Koruna Peg Ends

Updated on
  • Currency weakens Friday morning in signs of volatility
  • Bank shifts back to interest rates, interventions as tools

Having promised to spare the world from a currency shock like the one in Switzerland more than two years ago, the Czech central bank kept its word. Now comes the hard part.

After resurgent price growth rendered the policy obsolete, rate setters on Thursday scrapped a cap they imposed to avert deflation by keeping the koruna from appreciating. Now they’re dusting off old tools in a return to conventional monetary rules following three years of the currency being stuck weaker than 27 against the euro. It also starts a scramble by investors to unravel as much as $65 billion in long-koruna positions that they built up in the hope of a quick payoff.

The koruna’s leap to freedom looked nothing like the jump of as much as 41 percent in the Swiss franc that caught investors unaware when a similar cap was lifted there in 2015. It appreciated only about 1.6 percent against the euro in the first day, still far from regaining the 5 percent it lost the day it was shackled three years ago. The currency actually weakened on Friday, vindicating the central bank’s warning that investors may struggle to find counterparties to cash out their positions. The bank said it will intervene any time it deems necessary in a new managed float. It’s up to the market to probe its limits.

“The exchange-rate commitment is dead -- long live interest rates,” said Viktor Zeisel, an economist at Komercni Banka AS, Societe Generale SA’s Czech unit. The question now is: “how far is the central bank willing to let koruna fluctuate in either direction? How long will it wait until it starts rate normalization?”

Read more about what might happen now that the koruna cap has dropped

Governor Jiri Rusnok said policy makers will have “pain thresholds for both appreciation and depreciation” that are very wide and unlikely to be reached by the currency in the near future. “I definitely don’t expect us to be present in the market” in the immediate future, Rusnok said. He added that the first interest rate hike could happen as soon as in May. But he said that was unlikely and, the bank would like to see where the koruna settles first.

“We have to be patient, we shouldn’t be swayed by what’s happening in the first hours and days after the exit,” Rusnok told reporters in Prague on Thursday. “It’s a bit like when the patient is waking up from anesthesia. He may feel not so well for some time, but that doesn’t mean the operation wasn’t successful.”

Analysts differed on their estimates of where the bank’s limits may reside. Pavel Sobisek, chief economist at Czech unit of UniCredit, said policy makers would probably let the currency float between 25 and 28 against the euro, while Nomura Holding Inc’s Peter Attard Montalto said it could be between 25 and 27.5. Volatility showed itself on the first full day of trading after the exit, with the koruna weakening as much as 0.4 percent to 26.75 per euro early on Friday. It was trading at 26.64 as of 9:10 a.m. in Prague.

The latest official data show that the central bank bought 47.8 billion euros ($51.3 billion) in the four years through January to prevent the koruna from gaining beyond the cap. Adjusted for natural inflows seen in the balance of payments, the overall speculative position was about 50 billion euros to 60 billion euros as of March, according to estimates by Jan Bures, an analyst at the Czech unit of KBC Groep NV. ING Groep NV puts the intervention volume at about 36 billion euros so far this year.

But at least some of the speculative capital fled the koruna after the central bank stopped providing guidance at the end of March on the likely timing of the exit. The koruna has since shown volatility not seen in years.

“If you want to drop a currency peg, then the CNB can show you how to do it,” said Kathleen Brooks, head of research at brokerage firm City Index in London. “Dismantling a long-held currency regime doesn’t need to be as volatile or panic-stricken as Swiss peg debacle back in 2015.”

— With assistance by Marton Eder, Stefania Spezzati, and Selcuk Gokoluk

(Updates with koruna trading in third, sixth paragraphs.)
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