The Czech Republic may kick off Europe’s monetary-tightening cycle this week, jumping ahead of its peers after three years of stimulus fuelled price growth that’s sputtered on the rest of the continent.
Economists are almost evenly split, with 12 of the 22 surveyed by Bloomberg last week saying the Czech National Bank would raise its benchmark to 0.25% at its August 3 meeting from a record-low 0.05%. The rest predicted no change. If there’s a hike, it will be the first in more than nine years, and it would boost the appeal of koruna assets as other rate setters stay put and the European Central Bank holds off on announcing curbs to its quantitative-easing programme until fall.
While policy makers from the euro area to Hungary are waiting for more evidence that their economies have recovered enough to raise borrowing costs, the Czechs are spoiling for action. What sets them apart is an unconventional regime of near zero rates and interventions that clamped a lid on koruna gains from 2013 to April of this year. And while inflation is still moribund across the continent, policy makers in Prague are tackling price growth that’s risen above their 2% goal, spurred by a spike in wages and the lowest unemployment rate in the 28-member European Union.
“Czech inflation has been above the target, and a tight labour market suggests the economy is operating above its potential, a standard signal for tighter policy,” said Radomir Jac, chief economist at Generali Investments CEE in Prague, who sees a hike next week. “I expect the CNB to raise interest rates cautiously, in small steps and with longer pauses in between, at least until monetary tightening also becomes a reality in the euro area.”
The currency cap helped fend off deflation and boosted the competitiveness of exporters including Volkswagen’s Skoda Auto and brewer Pilsner Urquell. While Czech rate setters in Prague have repeatedly noted that koruna gains and the euro-area stimulus are limiting their scope for tightening, they said on June 29 they were likely to make a move this quarter.
Bets on rising interest rates have boosted the appeal of the koruna, which has surged 3.7% to the euro since the intervention regime regime ended on April 6, the most among 31 major currencies tracked by Bloomberg. The central bank previously said 1% of exchange-rate appreciation delivers about the equivalent of a quarter-point rate increase.
Another reason to tighten is the central bank’s wish to smother a potential mortgage bubble after Czech home prices grew at the fastest pace in the EU for two quarters. Policy makers have repeatedly said they prefer to cool the housing market through tighter capital requirements and lending standards, but their concern might tip the scale for a rate hike.
Still, some analysts are predicting no change. Jose Cerveira at JPMorgan Chase & Co in London says the new inflation forecast that central bankers will debate is unlikely to differ significantly from the one they’ve relied on for the past three months. The board will also want to wait for more clarity about the ECB’s tapering plans, he said.
Most money-market investors are also betting the first hike will be delayed until September, with forward-rate agreements that fix interest a month from now trading 7 basis points above Prague interbank offered rate.
“The CNB may also want to delay the move so that the period of policy divergence versus the ECB is shortened,” said Bank of America Corp economist Mai Doan, whose main scenario is for a rate increase on August 3. “But we think that it is just a matter of months for the hikes to come, so why the wait?”
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