Czech National Bank extends currency cap

By bne IntelliNews February 4, 2016

The Czech National Bank (CNB) moved to ease monetary policy further on February 4, as it officially extended its cap on the currency to 2017 and openly discussed negative interest rates.

While the move to extend the cap of CZK27 to the euro has long been expected, the CNB was even more dovish than the market had anticipated in its new inflation report. While rates were held at virtual zero - the level of more than 24 months - the discussion of further unconventional monetary methods such as negative interest rates illustrates that policymakers are increasingly concerned about inflation, as well as the the impact of looser policy in the Eurozone.

“This is the first time the bank has reported such a discussion since November 2013, when it first introduced the exchange rate ceiling,” Capital Economics commented. According to CNB’s new macroeconomic forecast, inflation should finally reach its 2% target in the first half of 2017.

The central bank noted that domestic headline inflation dropped further in the final quarter of 2015, getting close to zero mostly on the back of food and fuel prices. The forecast assumes that inflation will rise in early 2016 as food price growth resumes and the decline in fuel prices moderates.

Meanwhile, analysts take the official announcement on the extension of the currency cap as a definite date. Speculation has long abounded that the CNB would struggle to continue the policy against pressure from both the market and some Czech political circles.

The CNB "now expects to stop intervening on the FX market in H1 17", KB writes. "Thus, the 'hard”'commitment now corresponds to the probable exit."

However, analysts clearly assume the talk of negative rates will remain at the level of verbal intervention. "The [Czech] National Bank is clearly in a dovish mood," notes Capital Economics. "As things stand, we think the strength of the economy may prevent the council from pushing through looser monetary policy."

The central bank estimates Czech GDP grew 4.7% in 2015. However, growth is to slow to 2.7% this year (2.8% expected in the CNB’s previous forecast), reflecting a temporary decline in gross capital formation mostly because of a drop in government investment financed from EU funds.

On the other hand, the weak koruna and exceptionally low interest rates will continue to support the economy. Growth may also benefit from a further decline in the oil price and rising external demand. The CNB also expects slight acceleration of economic growth to 3% next year, with all components of domestic demand contributing positively.

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