The case of the Czech koruna
Exiting non-standard monetary policy measures
by Miroslav Singer in Prague
Wed 15 Mar 2017
As inflationary pressures stemming from renewed domestic demand increase, the Czech National Bank is likely to be one of the first central banks to revert to normal monetary policy tools. However, any changes in the conduct of monetary policy will probably be less dramatic than in January, when the CNB had to intervene in the foreign exchange market with unprecedented intensity.
Demand for Czech currency and the pace of inflows associated with it slowed considerably between January and February. There are several reasons for the dampened enthusiasm for koruna investment. The most important is investors’ gradual realisation that their exit from koruna positions back to the euro will be complicated. The €40bn increase in the CNB’s reserves since the introduction of the currency floor in November 2013 indicates that finding counterparties for trading koruna to euros will not be easy.
The Czech economy, supported by inflows of European Union funds, generates a surplus of around €500m per month. That may leave the CNB as the only possible counterpart for these trades. But it is doubtful that the central bank will be of any help to investors, given its apparent desire to lift the policy rate from its current ‘technical zero’ of five basis points to more normal levels. In addition, the CNB has few reasons to cut losses on its reserves.
There is no need for the CNB to reverse its prior purchases to relax monetary conditions. Given that it is likely to be able to keep inflation on target using short-term policy rates, it will have no reason to sell euros in the near future.
Additionally, the Czech economy will look different when it reverts to normal monetary policy than at the time of the introduction of the currency floor. There are growing wage pressures leading to stronger positions for Czech consumers. Czech employers may also choose to substitute investments for increasingly expensive labour. This is likely to lead to higher volumes of imports of both consumer and investment goods. As a result, the healthy current account balance may weaken.
Another factor that speculators should be aware of is time. As other central banks begin to normalise their monetary policy and raise rates to contain inflationary pressures, investors ’ koruna positions are not going to be cost-free.
It is doubtful that the CNB would allow the currency to strengthen more and thus risk another deflationary period. Any gains on the currency are likely to be insufficient to cover the costs of financing over the several years that may be necessary to unwind these positions.
The Czech exit from the currency floor is another reminder for investors that central banks may be relinquishing their role as the principal players on financial markets. Nevertheless, given their focus on inflation-targeting and ability to create money, one should take care when betting against central banks.
Miroslav Singer is former Governor of the Czech National Bank and a Member of the OMFIF Advisory Board. He is Director of Institutional Affairs and Chief Economist at Generali CEE Holding.
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