Česká národní banka

„Overbought“ Koruna Will Continue to Influence Czech Rate-Increase Debate

By Peter Laca (Bloomberg 15. 8. 2017)

The koruna holdings amassed by foreign investors during the Czech central bank’s three-year intervention regime won’t disappear any time soon and will continue to weigh on monetary policy deliberations for months to come, a board member said.

A strong domestic economy and interest rates exceeding those in the euro zone point to currency appreciation, Oldrich Dedek, a member of the policy-making board, said in an interview in Prague. But investors aiming to exit koruna positions may continue to tame gains, he said.

“We don’t yet know how much appreciation will actually occur, and we have been saying that the exchange-rate is a major risk for the forecast because the koruna is still overbought and there is the effect of the missing counterparty,” Dedek, 53, said on Monday. “I would see this as a medium-term phenomenon, rather than something that will fade away quickly.”

With inflation running steadily above the target, policy makers in Prague are weighing how and when to cool the economy further after kicking off European monetary tightening with the continent’s first rate increase this month. The bank said more hikes will come over the next two years, with the pace and timing depending on how much the koruna strengthens.

About four months after policy makers scrapped their Swiss-style limit on koruna gains, the legacy of more than three years of such unconventional regime continues to impact policy. An estimated $65 billion of foreign capital was converted into koruna before the exit. That’s prevented bigger currency swings as investors wishing to take profit - the koruna has jumped 3.4 percent against the euro since the intervention mechanism fell in April - are offsetting new inflows.

While data show declining koruna deposits, negative yields on state bonds with shorter maturities signal continued bets on future exchange-rate gains, according to Dedek. The koruna, since April the best performer among the 31 major currencies tracked by Bloomberg, has weakened 0.3 percent since the central bank raised its benchmark to 0.25 percent from 0.05 percent on Aug. 3.

“In general, the size of the speculative capital is still quite significant, and it could slow koruna appreciation,” Dedek said. “Also, some exporters have hedged future income, which will limit future natural inflows of foreign currencies. This is what we call the risk of the missing counterparty for those who would want to exit speculative koruna positions.”

The central bank has said the unpredictable outlook for the koruna is making it complicated to give more precise guidance for borrowing costs other than that included in the official prognosis. Capital Economics Ltd. has said the bank’s forecast implies two rate hikes next year.

“The external environment and Czech economic fundamentals are pointing in one direction, that rates will go up. The direction is clear, there is no doubt about it,” Dedek said. “We will be evaluating all signals from the economy to decide whether to move at a faster or slower pace with monetary tightening.”