CNB takes the peg off the koruna: moderate upside potential

Today the Czech National Bank (CNB) abolished the floor for the euro-koruna exchange rate that has existed since November 2013. This step is unlikely to have come as a complete surprise for market players as it is already some time ago that the central bank raised the prospect of ending this one-sided exchange rate peg in the second quarter. The fact that the market’s reactions remained within comparatively narrow bounds – immediately after the announcement the euro-koruna exchange rate only fluctuated by between +0.6% and -1.3% around the CZK 27.00 mark – is probably primarily due to the CNB’s energetic intervention. Although the CNB is not aiming for a concrete exchange rate level, recently in the run up to this step it has repeatedly emphasized that it will intervene vigorously to avoid any excessive exchange rate movements after the end of the koruna peg.

As the reasons for abandoning the exchange rate floor at the present point in time the Czech central bank cited the country’s solid fundamental performance. In this context, it emphasized not only economic growth, which has become far more dynamic again since the introduction of the exchange rate floor at the end of 2013. The CNB also drew attention to the fact that the disinflationary risks that made the introduction of this exchange rate peg necessary have been permanently averted and the inflation rate has now returned sustainably to within its target range of 2.0% (y-o-y). Given this positive development the central bank now believes it is appropriate to return to normality as regards monetary policy. The CNB says its sees dropping the exchange rate floor as the first step towards a gradual tightening of monetary policy. But some time is likely to pass before it really raises the key rate.

Even if the CNB were to be sought after in the market especially in the next few weeks with what are large volumes by its standards, we believe the central bank should ultimately be able to keep the koruna within the bounds it wishes. It should benefit from the fact that it is still in very calm waters as regards the technicalities of market intervention regardless of its comparatively intensive intervention in the market at the beginning of the year. It should also benefit from the fact that the market views it as credible. We therefore continue to credit the Czech currency with only moderate upside potential of at most around 4% against the euro over the forecast horizon.

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