The CNB’s FX commitment ended today. This was widely anticipated by the markets, and the reaction has been relatively moderate. The end of the FX commitment raises several important questions. How far is the CNB willing to let EUR/CZK fluctuate in either direction? How long will it wait until it starts rate normalisation? We expect the CNB to enter wait-and-see mode now and to be reluctant to hike any time soon as inflationary pressures look set to ease and price growth moderate in the coming months.
The FX commitment came to an end after having been in place for almost three and half years. At today’s press conference after the extraordinary meeting, Governor Rusnok said that the bank board took this action “On the basis of a thorough assessment of the available macroeconomic data, analyses and forecasting scenarios”. The central bank believes that “the conditions for sustainable fulfilment of the 2% inflation target in the future had been met”. We agree with this evaluation and thus perceive the scrapping of the floor today as a natural step.
The CNB continued to stress that it “stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed”. However, it has not indicated the level at which it will step back into the market. The CNB does not want to set a new level that could be perceived as a new floor. Recent comments by board members suggest that the CNB wants to give the CZK more freedom than we previously expected to find a new post-commitment equilibrium. We assume that the CNB would not react to exchange rate appreciation to EUR/CZK25. However, the CNB would probably react should EUR/CZK hit 28, as depreciation might jeopardise achieving the inflation target. We do not believe that EUR/CZK is set to approach either of these levels. We think the CZK will remain steady for now.
Interest rates to regain status as main monetary policy tool
The CNB forecasts assume rate hikes in the third quarter of this year. However, we believe that the CNB will not hike this year. Governor Rusnok has confirmed that the CNB is entering wait-and-see mode while the exchange rate finds its new equilibrium and the central bank gets visibility on the effects of the removal of the FX floor. Only after that will the CNB will discuss the amount it wants to tighten monetary policy (which now means hiking). We believe that the CNB will not hike rates this year despite its forecasts suggesting it will. During the summer, inflation pressures will likely prove weaker than the central bank expected in its last forecast. Wage growth has slowed and could even decelerate if the strengthening CZK cuts into firms’ profits and business expectations deteriorate. Governor Rusnok has indicated that inflation is set to ease from February’s 2.5%, in line with our forecast. We believe that the CNB will remain cautious until the economy gets used to renewed volatility on various markets.