By Michael Winfrey and Peter Laca (Bloomberg 2. 3. 2017)
Investors wanting reassurance from central banks may need to look elsewhere this time.
The Czech National Bank is ready for the market to turn “quite turbulent” after it removes its Swiss-style regime limiting currency appreciation, a decision that now appears most likely around mid-2017, Governor Jiri Rusnok said in an interview on Wednesday. The monetary authority won’t be overly concerned about short-term swings, which would be natural before the market returns to “normal conditions,” he said.
In one of the sternest warnings yet by the Czech central bank, Rusnok is staring down investors who are piling into koruna in expectation of a quick payout once the cap on gains is lifted and the currency appreciates against the euro. As policy makers prepare to abandon the unconventional stimulus introduced in 2013 to ward off deflation, the Czechs are intervening in record amounts amid what some banks are calling one of the top currency trades in Europe this year.
“If we were to pledge to completely mitigate koruna swings right after the exit, then, effectively, we wouldn’t be leaving” the regime,” Rusnok said. “What we’re saying is that there can be high volatility, and that it will be a period when those speculating on the koruna should be a little afraid, more than we need to be. Our pain threshold will be quite high.” Investors’ anticipation of the return to standard monetary policy has only intensified since inflation accelerated faster than the central bank had predicted at the start of the year. With January’s price growth exceeding the central bank’s target of 2 percent for the first time in four years, the monetary authority was forced to boost foreign-currency purchases to keep the koruna from gaining beyond the imposed limit of around 27 per euro.
ING Groep NV estimates that the central bank bought foreign currencies worth about 19.5 billion euros ($20.6 billion) in the first two months of this year, exceeding the 16.9 billion-euro intervention volume for all of 2016.
Pressure on the exchange-rate cap, visible in the currency-derivatives market, peaked in the first two weeks of the year, with the 12-month euro-koruna forward strengthening to as far as 26.5 on Jan. 11. The contract has since slipped back to about 26.7, a sign of investors paring bets on appreciation. Rusnok said the bank saw the koruna as “overbought.”
Consumer prices have been significantly influenced by the volatile cost of food as well as some one-time factors, and Rusnok said inflation reaching or even slightly exceeding the target isn’t an automatic trigger for a policy change. The bank wants to avoid a premature exit and needs to make sure it won’t need to go back to non-standard tools again, he said.
“We think that allowing inflation to exceed the target a little bit, within the tolerance band, is the right approach for leaving the foreign-exchange commitment,” Rusnok said. Read more on Czech preparations for ending intervention regime.
The so-called hard pledge that the central bank won’t scrap the currency cap before the end of the first quarter will expire in a few weeks. After that, anything can happen, Rusnok said. But he still considers the current outlook for leaving the exchange-rate cap at around the middle of the year as appropriate.
The rate-setting panel will analyze “all aspects and information” with even greater intensity as it moves closer to the policy change, he said. The board may make the move either in a regular monetary-policy meeting or at an extraordinary session, and since the actual decision will be the result of a vote, it won’t be possible to announce it before the ballot takes place, according to Rusnok.
What won’t happen is the type of shock that the Czechs’ Swiss counterparts unleashed on investors when they suddenly dropped their cap and sent the franc soaring more than two years ago, he said.
“So naturally, there may be some element of surprise,” the governor said. “But we have proven our transparency by clearly communicating that there will be an exit from this policy, that it will happen sometime after the first quarter. We are certainly not following the Swiss model of a surprise exit.”
On inflation:
“Inflation reached current levels a little bit earlier than we had expected. The development was significantly influenced by food prices, which are traditionally quite volatile. The anti-inflationary effect of oil prices is also fading away, and that’s in line with our expectations.”
“For us, the key condition for removing the foreign-exchange commitment is a robust fulfillment of the inflation goal. This means that we will be able to continue fulfilling the inflation target even after the exit from the foreign-exchange commitment, taking into account some appreciation of the koruna that may occur at some point in the future.”
“We don’t see any reason to exit the commitment prematurely just because inflation is at the target, or maybe slightly above the target.”
“Sustainable fulfillment of the inflation target means that we’re talking about the monetary-policy horizon. It’s not important so much where inflation is now or where it will be next month. What’s important is that the forecast will be showing us that we would be able to meet the inflation target, even if the koruna appreciated sometime after the exit. We want to avoid a scenario where we would exit the commitment, which will effectively mean tightening of monetary policy, and then we would find out in a few months that we did it too soon and need to loosen the policy again.”
On the timing of exit from currency cap:
“While the inflation development is to some extent ahead of our predictions, other signals from the economy are more or less in line with our expectations. We will be incorporating new data into our analysis, but there don’t seem to be any major deviations from the forecast for now. In my view, there is no major factor that would change the current timing of the exit.”
“What we have said is still valid; the current policy will not be removed until the end of the first quarter. After that, anything can happen, so to say, though for now the exit still appears most likely closer to the middle of the year.”
“Naturally, since we’re approaching an important decision, we have to address all aspects and information related to it with even higher intensity.”
On exit process:
“The bank board may take the decision either in a regular monetary-policy meeting or at an extraordinary meeting. It will be a result of a vote, so it won’t be possible to announce anything before the board takes the votes.”
“But we have proven our transparency by clearly communicating that there will be an exit from this policy, that it will happen sometime after the first quarter. In terms of transparency, that’s more than enough. We are certainly not following the Swiss model of a surprise exit. The Swiss situation was different and they addressed it in a different manner.”
On post-exit koruna moves:
“The koruna is really overbought now, and that will undoubtedly have an impact on the exchange-rate movements after the exit. We are aware of this, and we’re telling everybody that they should expect increased volatility after the exit, and this volatility could be very strong in the short term.”
“What we are saying is that there can be high volatility, and that it will be a period when those speculating on the koruna should be a little afraid, more than we need to be. Our pain threshold will be quite high. The market can be quite turbulent shortly after the exit before it returns to normal conditions.”
On interest rates:
“The exit from the commitment will be the first step toward tightening monetary policy, and raising interest rates will probably follow some time later. It’s premature to speculate now how soon rates will rise because we will need to see what happens with the koruna.”