Czech central bank shrugs off president’s warning shot

By bne IntelliNews February 20, 2015

Robert Anderson in Prague -


The Czech Central Bank (CNB) is standing by its policy of keeping the Czech crown weak - despite criticism this week from President Milos Zeman – because of the continuing danger of deflation.

In a speech at a CFA dinner in Prague on February 19, Miroslav Singer, central bank governor, said: "We have said we are concerned with the domestic demand at the current juncture. We are still in a highly deflationary environment and it is difficult to disregard such a risk."

The Czech inflation rate is currently 0.1% and has been under the central bank’s 2% target for two years, depressed by the Eurozone’s weakness and the fall in the oil price.

Singer said that the Czech Republic would have had an average deflation rate of 2% in 2014 without the weak crown policy, and gross domestic product would have grown by 0.5%, rather than 2.3%.

The central bank has been using verbal interventions to prevent the crown strengthening above CZK27 to the euro since November 2013 because it can no longer readily use its key interest rate, which is already virtually zero (0.05%). On February 5 it said it did not expect to change this policy before the middle of 2016.

The CNB has even hinted that it could target a weaker level of the crown.

“The CNB is prepared to move the exchange rate commitment to a weaker level if there were to be a long-term increase in deflation pressures capable of causing a slump in domestic demand, renewed risks of deflation in the Czech economy and a systematic decrease in inflation expectations,” Singer reiterated.

On February 18 President Zeman accused the central bank of using non-standard policy tools and of deliberately impeding the country’s progress towards adopting the euro.

“I’ll do everything to ensure that this respectable institution is filled in the future with people who will not do unnecessary experiments with the Czech economy and will support the country’s entry into the Eurozone,” said the president, who enjoys stirring up controversy but also has the sole right to appoint members of the bank board.

Zeman, as well as the ruling Social Democrats, support prompt adoption of the euro, while the central bank board – which was appointed by his predecessor, the eurosceptic Vaclav Klaus – is much more hesitant. Opposition to euro adoption in the country is also high, with around 75% opposed, according to polls.

Zeman, however, will have chosen five of the seven-person board at the central bank before the end of his first term in March 2018, so he will be able to remake it in his image.

Nevertheless a decision on joining the euro – which the country is obliged to do under the terms of its EU Accession Treaty - will only be made by the next government. The coalition has decided not seek to adopt the euro during its current term, which lasts until October 2017. According to an agreement with the central bank made in December, it will not set a target date or enter the ERM II this year.

One key factor will be the view of Finance Minister Andrej Babis, whose Ano party leads opinion polls. The billionaire was quick to attack Zeman’s comments on the central bank as an “unacceptable” interference with its independence, but he has yet to take a clear stance on euro adoption.

As Zeman’s comments indicate, the level of the crown will be another key factor when the next government looks at euro adoption. The crown must be much stronger than it is currently, Eva Zamrazilova, a former central bank board member, told Czech television on February 19."The crown has room to firm vis-a-vis the euro in the long run and so we should not move quickly to join the euro," she said.

The president’s intervention pushed the crown up 1.4% on February 18 to 27.185 per euro - the biggest intraday gain since November 2011 and the strongest level since 2013, according to Bloomberg. However, it retreated again on February 19.

In a note, Societe Generale said it expected the crown to weaken further. “With the looming period of dividend repatriation, with the real negative flow, and with lower inflation versus the CNB's expectation, we expect EUR/CZK to rise back toward roughly the upper end of January's trading band, i.e. we target EUR/CZK 28.00,” the analysts wrote.

Zeman’s comments are therefore a warning shot, but they are unlikely to have a big influence on central bank policy in the short term. “If Zeman had said he liked what we were doing, then we would have been in real trouble,” said a source close to the board.

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