The Czech central bank ditched its cap on the crown yesterday, sending the currency sharply higher as investors who have bet billions of euros on it strengthening traded it freely for the first time since 2013.
The decision came as the bank’s board met for a weekly non-ratesetting meeting, its first scheduled opportunity to scrap the weak crown policy since a promise to leave it in place until the end of March expired.
The upper limit of 27 for the crown’s exchange rate to the euro was the cornerstone of the central bank’s (CNB) ultra-loose policy programme to revive inflation, and the Czech currency has been pushing at that cap since mid-2015.
The crown duly rose after it was lifted, but the gain of 1.7% to 26.575 to the euro was relatively muted — a sharp contrast to the chaotic few minutes of trading that followed the Swiss National Bank’ unexpected removal of the franc’s cap against the euro in early 2015.
That reflected groundwork the CNB had laid, after inflation has returned to the bank’s 2% target in February.
It signalled last week at a regular policy meeting that the cap was near an end.
“The decision came in a situation when the foreign exchange market has been calm for several days and acute pressures for crown firming were not seen,” UniCredit’s chief economist in Prague, Pavel Sobisek, said.
“That should reduce volatility of the crown rate in the (next)...days.”
Investors are betting the crown will start to firm further now that it is free, and a Reuters analyst poll released yesterday and conducted before the cap was lifted, forecast the currency will gain 5% over the next year.
Bank Governor Jiri Rusnok said it would allow a degree of volatility in the currency’s exchange rate without intervening until it settled into a new trading range.
“The point is for the crown to find...some new equilibrium level, which should gradually reflect fundamentals of the Czech economy,” he told a news conference.
The bank did however reiterate it would be ready to step into the market to smooth excessive swings.
Markets are expecting volatility due to the massive positions built up by investors. Analysts have estimated speculative market positions could total anywhere from €25bn to €60bn.
Yields rose yesterday on Czech short-term bonds as some closed positions in the papers that have been popular with foreign investors betting on the crown in recent months.
Investors have been betting heavily on the exit, causing the bank to buy up billions of euros to defend its cap.
But the market hit a lull this week after speculators expecting an earlier exit closed positions and weakened the crown somewhat. The decision to let the crown loose follows a rise in inflation to 2.5% in February.
The central bank sees inflation rising closer to 3% later this year.
It has forecast the economy to grow close to 3% this year and in 2018, after posting 2.3% growth last year.
The stronger crown will make imports cheaper but puts a strain on the economy by making exports less competitive.
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