Slovak koruna continues upward march as euro peg reset

By bne IntelliNews March 20, 2007

Nicholas Watson in Prague -

The Slovak central bank said Monday "there is no reason for the koruna to strengthen dramatically" from the new central parity rate against the euro, though many economists and strategists would appear to disagree.

The Slovak koruna jumped by more than 3% to record highs against the euro Monday after the European Central Bank announced late Friday it and the other members of the Eurozone had acceded to the National Bank of Slovakia's (NBS) request to revalue the currency's peg within the ERM-2 grid, which is the precursor to adopting the euro, in order to take account of the continued strengthening of the currency in the markets.

The peg was moved 8.5% to give a new central rate for the crown of 35.4424 koruna per euro and under the rules is allowed to fluctuate 15% on either side of that level – 40.759 and 30.126 per euro. The revaluation of the central parity rate explicitly created room for further appreciation, which it duly did by hitting a record high of 32.710 per euro by mid-afternoon – halfway to the stronger end of the new band.

The revaluation was not in itself a surprise; it has been discussed for months as the koruna relentlessly rose along with Slovakia's economy, which is powering ahead towards its date with the euro probably in 2009.

"The revaluation of the central rate of the Slovak koruna is justified by underlying fundamentals," the ECB said in its statement.

Indeed it is: on March 6, Slovakia revised up its preliminary estimate for GDP growth in the fourth quarter of 2006 by 1 percentage point to 9.6%, just shy of the 9.8% rate posted in the third quarter, which was the highest growth in the country's history. For the whole of 2006, the economy grew by 8.3%, significantly accelerating from the 6.0% growth recorded in 2005. Meanwhile, the industrial production index reached a new high of 17% in January, while the trade surplus came in at €4.0bn in the same month.

These numbers have prompted economists to rejig their GDP forecasts for this year, with UniCredit Group predicting economic growth will come in at 9.0% this year, rather than the 7.5% it had previously forecast.

Size and timing

The surprise with regards to the revaluation came more in the level of the move – 8.5% versus the previous revaluations of Greece (3.5%) and Ireland of (3.0%) – and the timing, which was sooner than many had predicted.

"We think January’s excellent trade balance figures triggered this move when they registered a SKK12.2bn year-on-year improvement," says Anne-Francoise Bluher, an analyst with Societe Generale Group. "This indicates that not only we, but also the [Slovak central bank], are convinced that the trade balance is at the beginning of a significant improving trend and this will generate considerable appreciation pressure on the koruna."

Many analysts suspect that the most positive data has actually yet to be released, which would point to the currency appreciating further from here. "We expect that a moderate appreciation trend will continue even from already much stronger levels," say economists at Raiffeisen Zentralbank Österreich, who are re-evaluating their predicted conversion rate for the euro of 33.50.

SocGen's Bluher also reckons the Slovak crown has the potential to appreciate further. "We put the conversion rate of the koruna into the euro at 31.40. Yet, we perceive the risk for surprises to be on the appreciation side, and therefore we would not rule out completely that the parity rate will be revalued further on the one-year horizon and that the conversion rate will be even below 31.40 at the end," she says.

Central bank board member Karol Mrva told Reuters that the koruna's actual conversion rate to the euro, which might be set in the middle of 2008, could be different from market levels.

Mrva also showed the central bank's willingness to intervene verbally to try to keep a lid on the koruna's appreciation. "The new parity level is close to the equilibrium exchange rate. Therefore, there is no reason for the crown to strengthen dramatically from there, and the exchange rate should move around that area," he said.

These remarks echoed those of the NBS Governor Ivan Sramko, who told a news conference the koruna is too strong. "We consider the exchange rate that developed over the weekend as overvalued and caused by too low liquidity," he said.

Whether the NBS will intervene physically, like it did throughout 2006 by buying euros and flooding the money market with excess liquidity, remains open to question, though Mrva held out the possibility by insisting the NBS is ready to use all tools available, including interventions.

Yet some believe the NBS is more likely to start cutting rates to achieve this, as the stronger crown will help to bring down inflation, which stands at around 2.7%.

"We do not expect more than a 25-basis-point rate cut at the upcoming monthly board meeting on monetary policy on March 27," say economists at Raiffeisen. "More radical rate cuts are possible if the NBS is not able stop a potential further appreciation via verbal and direct interventions."

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