Czechs can avoid Swiss disruption, says governor
By Lucy Fitzgeorge-Parker (Euromoney 12. 2. 2015)
Exchange rate regime set to run into mid-2016; CNB ready to act to prevent market shock.
The Czech central bank will be able to exit its current exchange rate targeting regime without causing a Swiss-style market disruption, says governor Miroslav Singer.
Speaking to Euromoney in Vienna on January 21, a week after the Swiss National Bank (SNB) roiled markets by removing the cap on its currency, Singer says: "Our plans for exit are, to put it diplomatically, rather different from the Swiss manner of exiting."
In what he insists is not a comment on the SNB’s surprise decision, which caused the Swiss franc to appreciate by more than 20%, he adds: "I believe that normally exits from unconventional monetary policies are carried out in situations where the central banks is sure that it will not resort to using them again within a few months."
Singer says that this would be the approach adopted by the Czech National Bank (CNB), which began using exchange rate targeting as a monetary policy tool in November 2013 after a year of interest rates at the zero bound failed to revive inflationary pressures. A floor of 27 for the euro-koruna rate was set and the CNB undertook interventions to push the currency above that level.
Lifting the floor
"Once we are sure that we are in a situation where we are looking at interest rate hikes in the foreseeable future and can afford some currency appreciation, or even where we are seeing the trade balance shifting due to growth in domestic consumption, then we will consider lifting the floor on the koruna," he says.
"One thing is for certain – we are not going to exit until we are damned sure we will not have to re-enter immediately."
The danger of this approach, according to analysts, is that by the time the CNB removes the currency floor there may be strong appreciation pressures. "The Czech economy is growing faster than the eurozone but the inflation rate is the same, which indicates that real convergence has restarted, and in that case the longer we stay in the exchange rate regime, the higher pressure there will be on the currency at the time of exit," says Jan Bures, chief economist at Ceskoslovenska Obchodni Banka (CSOB) in Prague.
Singer makes it clear, however, that the CNB would be prepared to step in to avoid a sharp appreciation – or depreciation – of the koruna. "We are always ready to prevent abrupt fluctuations of the exchange rate," he says. "The Czech Republic is not an economy that can afford to have the currency moving by 10% within a few days."
As to precisely when the CNB might exit the targeting regime, Singer refuses to be drawn, but the bank announced last summer that the exchange rate floor would be extended into 2016. Following a very low inflation print in December – the headline rate fell from 0.6% in November to 0.1%, well below the CNB’s 2% target – analysts said the second half of the year was more likely than the first.
Indeed, recent debate has focused on the likelihood of the CNB increasing the floor – potentially to 30 koruna to the euro – rather than removing it. William Jackson, senior markets economist at Capital Economics, wrote in a research note in late January that "it seems likely that the CNB [will move to] a weaker exchange rate later this year".
The CNB first mooted the possibility of shifting the floor last summer. For the moment, however, Singer insists that such a move would not be necessary as two of the three main deflationary pressures – very low oil prices and low food prices – are likely to be temporary.
"The best you can assume about the next harvest is that it will be an average one, so food prices should be back to normal in a year’s time," he said, "and in terms of the oil price, unless you are willing to consider the possibility of another drop by $50 to zero, that should also factor out of inflation figures by 2016."
Singer acknowledges, however, that the CNB remained concerned about the risks to the Czech economy from deflation in the eurozone. "That situation will be with us for a while," he says, adding that the bank will also continue to closely monitor domestic indicators, including levels of investment, consumer behaviour, velocity of money and core inflation.
Another reason for the CNB not to move the exchange rate floor, says Bures, is that the bank’s known willingness to do so has proved very effective in keeping the koruna weak. "Most of the CNB’s interventions took place at the start of the process when they needed to convince the market that they had the ability to maintain their target level for the koruna. Since then the rate has been above the target, due to the expectation that the CNB could move the target rate even higher."
Singer confirms that the CNB regards communication as a big monetary policy tool. "When we designed our exchange rate regime we looked at the Swiss model and one thing we took from that is that it is very dangerous to draw a line in the sand and say it will never change," he says. "We are ready to change the floor if needs be and I believe that that in itself stops anyone betting on the exchange rate getting close to 27 in a situation where there are deflationary pressures."