Czech Republic: Central Bank scraps currency cap
April 13, 2017
At its 6 April extraordinary meeting, the Czech National Bank (CNB) decided to withdraw its 27.0 CZK per EUR exchange rate floor and announced that from now on the CZK will be allowed to float according to market demand and supply, ending a policy that started in late 2013. The timing of the decision confounded some market analysts—the latest ordinary meeting had been held just a week before—but the move itself came as no surprise as the CNB had been giving clear forward guidance in its latest statements. The CNB used the exchange rate as an additional monetary tool to prevent consumer prices from falling as a result of lower import prices, after the interest rate was set to its current “technical zero” and the Bank had no other instruments to influence inflation expectations.
Inflation grew to an over four-year high of 2.5% in February after January’s 2.2%, thus moving further above the Central Bank’s target of 2.0%. Moreover, leading indicators suggest that the Czech economy is experiencing a phase of healthy expansion, with manufacturing growing steadily and consumption supported by a tight labor market and rising wages. Additionally, in recent weeks the Bank had to sterilize large speculative inflows as investors poured into Czech assets in anticipation of the cap’s withdrawal. This prompted the CNB to buy a large amount of foreign assets, driving its foreign exchange reserves to around 60% of GDP.
The statement makes clear that the Bank will allow the exchange rate to move in both directions going forward, but that will nevertheless mitigate excessive FX fluctuations if needed. In the aftermath of the decision, the market reacted quite smoothly, with the CZK-EUR exchange rate appreciating only moderately. Since it is quite likely that in the near future many operators will try to unwind their large speculative positioning, the Bank may be forced to take decisive action on the markets to prevent excessive fluctuation in the currency.