How will the market respond to the removal of the FX floor? Only time will tell. Here at AmCham, however, this certainty didn't stop us from playing ´fortune-tellers´ during the panel discussion, organized by our Finance Committee. Together with Eva Zamrazilová of the Czech Banking Association (CBA), Jan Vejmělek of Komerční banka (KB), and Petr Budinský of the University of Finance and Administration, we tried to predict the exact egress date and hypothesized how the exchange rate will be affected by the exit. We also tried to determine whether the Czech president´s comment regarding the exit date had any impact in terms of currency speculators. Lastly, we asked, what effect have the interventions had on the Czech real estate market? Read on.
It´s been over three years since the Czech National Bank (CNB), fearing deflation, committed to the goal of maintaining the Czech Koruna (CZK) exchange rate at approximately 27 crowns to the Euro (EUR). This objective has been undertaken by using the Czech currency – as opposed to interest rates – as the policy tool to achieve CNB´s inflation target of 2%. Now, the likelihood that the Czech National Board will not extend the intervention regime, increases ever more. Surprisingly, the inflation target was reached in December 2016, although the CNB wasn’t expecting to reach it until Q3 2017.
According to the forecast of Komeční banka, inflation is likely to overshoot the CNB’s target through 2017, to average at 2.2%. At the beginning of the year, the base effect in fuel and food prices pushed inflation up, while over the rest of the year, the core element will be the main driver. KB forecast also clearly shows that reaching the inflation target was not a one-off event and that it also is sustainable over the horizon of the monetary policy. Core inflation will be around 2.4% on average, this year, due to the tight labour market, which is causing nominal wages to surge. They are expected to rise by 4.6% this year. The last time wages grew at this rate was nine years ago.
This rise in domestically-driven inflation makes it seem as though the previously formidable hurdle for the removal of the FX floor has been eased.
"The moment of an end of the exchange rate commitment is clearly approaching," added the chief economist of the Czech Banking Association, Eva Zamrazilová. But, according to her, the end of the commitment does not equal the end of the interventions. The longer the exchange rate commitment will be extended, the longer the period of volatility will be. Pressure on wages in the labour market will continue, and if the central bank delays the exit, we may see still greater wage-inflation pressures, alleges Ms. Zamrazilová.
So far this year, the rate of both existing and expected developments has been reflected in a strong inflow of speculative capital into the Czech market. This situation has resulted in extreme swings on the forward, money and bond markets. Komercni banka estimates that, over the first three weeks in January, the CNB bought €13bn as part of its interventions in defense of the FX floor. Capital inflow slackened in the second half of January. The Czech koruna appears to have been overbought. In terms of volatility, according to KB´s forecast, movements of speculative capital will be the main driver for exchange rates in the first weeks and months, while economic fundamentals will play second fiddle.
Czech President´s Commentary
At the beginning of last week, during president´s visit of the Olomouc region, Milos Zeman said that he was convinced that the CNB forex interventions will end before in the middle of this year.
“President´s commentary had a significant impact on the market – a huge speculative flow followed,” said Mr. Vejmělek.
The Czech president has been an opponent of foreign exchange interventions for a long time. It is within his power to name and remove constituents of the seven-member CNB Bank Board, including CNB governor and vice-governors.
Milos Zeman placed a political cycle in the Czech Republic. He will run for another term in national elections slated for January 2018 and he might want to give his voters cheap holidays.
The exit date
The CNB governing board believes the second quarter of 2017 to be most the probable time for abandoning the former pledge.The forecast of Komeční banka assumes that the FX floor will be discontinued as early as the second quarter of this year. Given how transparent the central bankers have been thus far, a regular meeting on the 4th of May appears probable. A new inflation forecast will be available to the CNB Board at its scheduled meeting to discuss the monetary policy on that day. Should the central bankers get a surprise from the CNB, they are not ruling out the option of removing the floor in what would undoubtedly be an extraordinary meeting.
Judging by what has been articulated thus far, it seems that the path to exit is clear.
The only question which remains is the exact date. Despite the aforementioned prediction, many Czech economists are in favour of removing the floor on the Czech koruna against the euro unexpectedly – the same way as the Swiss National Bank (SNB) made in 2015. The unforeseen decision to remove the 1.20 floor on the Swiss franc against the euro has been heavily criticized for causing severe stress and prevalent bankruptcies in the Swiss currency market