Czech Republic: Central Bank leaves rate unchanged, maintains currency cap
May 5, 2016
At its 5 May monetary policy meeting, the Czech National Bank (CNB) met market expectations when it held its two-week repo rate at 0.05%. The CNB also affirmed its one sided exchange rate strategy that sets a floor of 27.0 CZK per EUR, which the koruna is not allowed to appreciate beyond. The Bank is trying to stimulate the slowing economy and bolster inflationary pressures by keeping the repo-rate at near-zero levels and setting a limit on the currency’s appreciation.
The Czech Republic has been struggling with weak inflationary pressure for the past two years. The CNB has not seen inflation above its 2.0% target since December 2012. In fact, inflation has been under 1.0% since December 2013. Low price growth on a global scale is not helping matters. As a result of the persistence of low headline inflation, the CNB stated at its March policy meeting that it anticipates lifting the currency cap later than expected and affirmed this view in its May monetary policy statement. The Bank also stated that it expects inflation to reach its target by mid-2017.
Implementing negative interest rates as a solution to the country’s weak inflation has been discussed. However, officials have implied that they consider the practice risky and have instead opted for currency manipulation as the preferred policy action. Although some market analysts foresaw the Bank employing negative interest rates this year, the likelihood is decreasing. Foreign exchange intervention—the selling of korunas and the purchasing of foreign currency—has moderated in the past months, suggesting that the appreciatory pressure is fading.
The CNB has again lowered its inflation outlook over its forecast period, particularly due to lower food prices, which is consistent with its view that risks to inflation are weighted toward the downside. This owes to the fact that price growth in much of the Euro area has been near zero or negative. The CNB is vigilant regarding these risks and stated that it, “stands ready to shift the exchange rate commitment to a weaker level if there were to be a systematic decrease in inflation expectations manifesting itself in nominal variables, especially wages.” It also stressed that the exchange rate cap will not be removed before 2017 and kept open the option of utilizing negative interest rates.
Author: Robert Hill, Economist