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CNB to continue FX commitment but not for long

Company: Komerční banka, a.s.

The Czech National Bank (CNB) has decided to continue defending the EUR/CZK27 floor but will likely discontinue the measure at its next meeting. Inflation is currently above the 2% target, and both our and the CNB’s forecasts point to an overshooting of the target in the next 18 months. Moreover, the bank board’s statement dropped its guidance for a probable exit from the FX commitment around mid-2017 and sees the risks to its inflation forecast tilted to the upside. This suggests that the EUR/CZK floor will be abandoned sooner than we had expected. Given the many holidays in the calendar, we see the board meeting of 20 April as a suitable date, but we cannot rule next Thursday 6 April.   

At the press conference after today’s CNB’s board meeting, Governor Rusnok did not shed any light on the timing of the exit from the FX commitment. However, the board did drop its guidance for a probable exit in mid-2017 and did not replace it with a new one. The risks to the inflation forecast were evaluated as being to the upside, especially in the short term. In the longer term, the risks are seen as more mixed, as wages in the business sector are growing slower than expected and economic dynamics are lagging expectations.

In light of today’s meeting, we expect the FX floor to be scrapped within the next six weeks. It could happen at an extraordinary monetary policy meeting called any time in April (we assign an 80% probability to this) or at ordinary monetary policy meeting on 4 May (20% probability). Any Thursday is a candidate, as the bank’s board meets then to discuss issues other than monetary policy agenda. Nevertheless, given that Thursday 13 April is followed by the Easter holidays and 27 April is followed soon after by Labour Day, the absence of domestic traders might heighten the volatility induced by the exit. We are thus left with next Thursday (6 April) and 20 April as the most probable options. However, an extraordinary meeting might be called for any other day.    

CNB forecast assumes hikes, but we believe the central bank will stay on hold

The CNB forecast assumes rate hikes shortly after exiting the FX commitment. However, removing the EUR/CZK floor amounts to monetary policy tightening. Moreover, the exit will induce a surge in volatility on the FX market. We thus expect the CNB to enter wait-and-see mode in the months after the exit. Only after it sees the effects on the financial market will it decide on hiking rates. Our models indicate weaker inflationary pressures than the CNB staff forecasts, and we believe that the CNB will revise its inflation forecasts downwards when wage growth and core inflation prove weaker than it currently expects. This supports our call for the CNB to hike later than assumed by the bank’s forecasts. We think that the first hike will come as late as the second quarter of next year. 

Tags: Economics | Finance |

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