The Czech National Bank (CNB) announced in an extraordinary meeting on the 6th of April 2017, that the central bank’s board has voted to remove the over three years currency cap of the Czech koruna (CZK) against the euro (EUR), which was set near $27.00, as the inflation rate returned to CNB’s target range. Right after the announcement on the central bank’s website, the koruna experienced sharp fluctuations on both sides before extending its appreciation. The EUR/CZK pair is currently in a free fall, marking the biggest one-day run since October 2011, shaking the forex market. As we speak, the currency pair is being traded at 26.60.
As we mentioned in our article published earlier this year “Clock Started to Tick on EUR/CZK Currency Floor”, in November 2013 the CNB, inspired by the Swiss National Bank (SNB), decided to use the koruna exchange rate as an additional instrument for easing monetary conditions to prevent deflation in the economy, after interest rates plummeted close to zero percent in late 2012. The peg was initially agreed to hold until the second quarter of 2017. The foreign exchange interventions aimed to weaken the Czech koruna in order to push inflation in the central bank’s target range of 1% to 3%, in a similar way to using interest rate cuts for monetary easing. An excessive appreciation of the currency could put the competitiveness of the Czech economy at risk, something that CNB wanted to avoid. It is worth mentioning that the Czech Central Bank itself is the Koruna’s issuer, thus it is able to print an unlimited amount of money for an unspecified period of time to buy euros with Czech koruna and prevent overvaluing of its domestic currency.
Even though the central bank has not until this point indicated any expected changes, after the Czech headline inflation rate accelerated to 2% in December, the dilemma whether or not CNB will remove or lower the currency floor to alter the Czech koruna exchange rate versus the euro, became a topic of discussion amongst investors. Inflation, in fact, jumped to 2.5% in February, prompting the central bank to remove completely the foreign exchange commitment. However, they left the two-week repo rate at 0.05%, the discount rate at 0.05% and the Lombard rate at 0.25%.
The market needs some time to digest the unexpected CNB’s move while the bank states that it is ready to use its instruments to mitigate the potential excessive exchange rate fluctuations.
