The Czech National Bank surprised the markets on April 6 as it announced it has scrapped its cap on the koruna.
The announcement comes just days after the end of the central bank’s “hard commitment” to keep the currency pegged at CZK27 to the euro through the first quarter of the year. Comments from the CNB following a monetary policy meeting on March 30 had only spread more confusion for investors, who have poured billions into koruna-denominated assets in recent months as they bet on a jump in the value of the koruna when the regime is lifted.
However, the CNB surprised many by ending the regime almost immediately. The move, which was decided at a non-monetary policy meeting, appears to have been pushed by the continued ‘CZKexit’ frenzy, the rising level of forex reserves due to spiralling intervention demands, and a surge in inflation around the turn of the year.
The central bank has been scrambling for months to talk down the inflows of speculative capital, noting that it still stands ready to intervene after the cap is removed. It has also insisted the currency could actually drop as investors seek to unwind their huge positions.
The central bank repeated the mantra in its statement on April 6, in which it notes that the decision takes effect immediately.
“The discontinuation of the use of the exchange rate as an additional monetary policy instrument means that the koruna exchange rate will move according to supply and demand on the foreign exchange market,” the CNB said. “As a result, it may fluctuate in either direction in the short term. The CNB stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed.”
"The currency obligation has fulfilled its objective," CNB Governor Jiri Rusnok told a press conference later the same day. Since the regime was introduced in 2013, GDP has grown by around 10%, he claimed, with 2-3pp stemming from the cap.
Those words were a reminder to the market that the regime was originally planned as a stimulus to the economy. Over the last couple of years, commentators have focussed almost entirely on its effects on inflation.
The regime helped boost Czech GDP to a heady 4.6% growth in 2015, while the country was the only one of the Visegrad Four to evade the deflation that has stalked the region. While economic growth slowed to 2.3% last year, it was the surge in the CPI from December that sent investors into a frenzy.
The koruna rose immediately on the back of the news, although volatile trading saw it oscilating close to the cap. However, the currency steadily picked up momentum through the afternoon, trading at CZK26.6458 to the euro by around 16:00 CET.
Although mostly surprised by the speed of the move, analysts largely expect the koruna to appreciate through the year. “The move came earlier than we and most others had anticipated,” said Capital Economics, which had forecast the regime would last until May. “We will let the dust settle before revisiting our forecasts, but as things stand we think the ‘fair value’ of the currency is around 25.5/€ (5.5% stronger than its current rate) and we expect it to settle around that level by year-end.”
“We forecast €/CZK at 26.50 for the second half of the year on average and 25.50 in 2018,” said Raffaella Tenconi at Wood & Co. “Bigger currency appreciation in our view is unlikely as there is a sizeable bond positioning that will likely be gradually liquidated and beyond 3-4% appreciation a year the CNB will begin to question whether it is sustainable for the fundamentals of the economy. We expect a mild rate tightening cycle to start in the second half of the year.”
"Overall, the fundamentals point to koruna strengthening in the medium-term," agree analysts at Oxford Economics. "However, long koruna positions are estimated to be above €50bn – an excessive figure for a relatively low liquidity market such as Czech."