Four months ago we showed that according to 6 month EURCZK forwards - driven by a recent surge in Czech inflation - the market was convinced the Czech central bank would end its Koruna peg to the Euro some time before the summer.
As ING stated at the time, “It shows that the market is positioning against the CNB floor more intensively, as accelerating inflation is increasing the odds of the approaching exit. The Dutch bank said it expected the currency regime to be scrapped around April or May, with annual inflation forecast to climb from 1.5 per cent to 1.9 per cent in December – close to the central bank’s 2 per cent target.
“If the intensity of interventions saw during the first days in January continues in the first quarter of 2017, total interventions in the quarter might easily overcome the whole 2016-levels”, he added.
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Moments ago all those traders who bet heavily on an end to the currency peg were rewarded when the Czech National Bank announced that just like the SNB over two years earlier, it ended its regime limiting koruna appreciation, in the process setting in motion one of this year’s biggest currency trades which according to Bloomberg has attracted as much as $65 billion in estimated capital. The announcement caught some by surprise as it came during a non-rate setting meeting, diverging from the original view of it being done at a scheduled monetary policy meeting in May
In anticipation of the peg's end, investors betting on koruna gains had poured into Czech assets, boosting foreign capital inflows in multiples of the levels normally seen in the country’s balance of payments. But, as Bloomberg adds, at least some of the speculative capital fled the koruna after the central bank stopped providing guidance at the end of March on the likely timing of the exit. The koruna has since shown volatility not seen in years.
The central bank’s board voted to exit the Swiss-inspired intervention regime at a meeting in Prague on Thursday, removing a policy that kept the koruna weaker than 27 per euro for more than three years. The decision, announced in a statement on the bank’s website, came a week after its pledge to keep the one-sided peg in place expired in March. It triggered moves sending the koruna both above and below the level of the cap.
“The CNB stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed,” the bank said in the statement. The monetary authority will hold a news conference at 2:15 p.m. in Prague.
The seven-member monetary-policy panel abandoned the limit in response to rising inflation and ahead of the ECB scaling down its own unconventional stimulus. As Bloomberg notes, the Czech decision highlights a diverging approach to resurgent inflation in central Europe’s economies, with Hungary continuing easing without touching its benchmark rate and Poland forecasting stable borrowing costs in the coming quarters. The Czechs originally imposed the cap in 2013 to avert deflation.
According to the latest official data, the central bank bought €47.8 billion ($51.3 billion) in the four years through January to prevent the koruna from gaining beyond the limit. Adjusted for natural inflows seen in the balance of payments, the overall speculative position was about 50 billion euros to 60 billion euros as of March. ING Groep NV puts the intervention volume at about 36 billion euros so far this year.
Ironically, central bankers had cautioned that the accumulated speculative position is so large that investors hoping for a quick payoff from koruna appreciation may struggle to find counterparties for their positions in the currency after the exchange-rate limit is removed. The koruna swung between 26.81 per euro and 27.17 per euro, trading at 26.90 as of 12:36 p.m. in Prague.
Indeed, as shown in the chart below, the initial response to the peg removal has been relatively modest.
Not so much other Czech assets, however, as Czech bonds slumped, with shorter maturities leading declines:
- 2-year yield +20bps to minus 0.18%, highest in 8 months
- 10-year yield +8bps to 0.91%
Elsewhere in central Europe, in reaction to the Czech central bank announcement, the Polish zloty gained 0.1% to 4.2282 per euro and Hungarian forint appreciates 0.2% to 309.72/Eur.
Governor Jiri Rusnok said after the March 30 policy meeting that the bank will be ready to mitigate excessive koruna swings after the exit. But he also said earlier in March that policy makers won’t be “overly sensitive” to initial swings, which could be in either direction, and will let the market find a new equilibrium.
After the initial calm, we expect the EURCZK to drift steadily lower as market forces normalize.
In the aftermath of the announcement, Nomura said it sees the Czech central bank intervening only if EUR/CZK gets well below 25, or on the upside if going over 27.5. He added that the central bank is looking for a monetary tightening and wants a currency rally, and “if not, they will have to start hiking rates later in the year."