CNB threatens to raise floor for EUR/CZK

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CNB threatens to raise floor for EUR/CZK …

… and President Zeman shows his displeasure

Shortly after the CNB Board meeting, a verbal intervention provoked depreciation of the Czech currency by tens of hellers. The koruna lost in response to Governor Singer’s statement that risks of its weakening due to a shift of the intervention exchange rate level had increased since the last but one Board meeting. The statement acted as a red rag in front of the eyes of President Zeman, who did not let markets wait long for his deprecatory reaction, owing to which the koruna wiped out part of its losses.
The crucial problem now is, whether a shift of the intervention level from the current CZK 27.0 per EUR towards 28-29 EUR/CZK has been something we should be really concerned with in foreseeable future? In our view, the scenario is less likely than unlikely for a couple of reasons.
First, the Czech economy is not in bad need a weaker exchange rate. Although CNB’s optimistic bets on a rapid wage growth will not be fulfilled, other data from the beginning of 2015 look quite optimistic, including consumer inflation, which - excluding fuel prices - has grown to its maximum since December 2008.
Secondly, while the koruna has strengthened against the euro in recent weeks, the turbulent euro-dollar development means that it has significantly weakened against the US dollar as well as against other currencies pegged to the USD. In other words, the effective koruna exchange rate (reflecting currency composition of the Czech foreign trade basket) has been moving in the opposite direction to the EUR/CZK in recent months, i.e., it has been weakening.
Thirdly, if the CNB significantly weakens the EUR/CZK exchange rate, it will further complicate its exit from the intervention regime. Fourthly and finally, we must not forget how (negatively) targeted weakening was adopted by the Czech public. Popular mood has been consistent with President’s disapproval of koruna devaluation. And President Zeman should appoint four new members to the seven-membered CNB Board, including the new Governor, as early as next year...
It is possible that the Czech koruna forgets about testing the level of CZK 27.00 per EUR for some time. Fundamentally, further scenario will greatly depend on readings of major Czech macroeconomic indicators – inflation, wages, industry and, of course, GDP. The koruna may get more nervous ahead of the data releases and, in particular, ahead of May’s CNB Board meeting, where a new inflation forecast will be submitted. Nevertheless, positive effects stemming from the inflow of euros printed by the ECB should prevail in the Czech economy; after all, the letter already starts to be visible, as Czech interest rates, i.e., bond yields, have been tending to slip into negative territory.