One of the more unusual exchange situations is that of the Czech koruna vs the euro.
The non-eurozone Czech Republic has a significant shared manufactured relationship with its fellow EU members, particularly with Germany. The Czech Republic manufactures or assembles automobiles or related products for the German auto industry.
Over the past several years, the Czech economy has benefitted from this relationship as automobile sales set records globally.
Further, the reduced cost of industrial commodities, including petroleum, has been particularly beneficial. However, a large portion of those record setting sales originated in Asia, particularly from China.
Nearly 40% of Germany’s exports to China are transportation vehicles or related equipment and parts. Similarly, about 40% of exports to the US and about the same to the UK originate from Germany’s transportation industry.
The Czech economy (as well as Hungary and Poland) is in large part a function of Germany’s industrial sector. A recent report has indicated demand side concerns for such exports, and the Czech National Bank has also lowered its economic growth forecast. Might this be an echoing of EU export concerns?
At the most recent meeting, the CNB noted low producer prices in Europe. This presents a particular problem for the CNB. Over the past several years, the central bank has stubbornly maintained a floor under the EUR/CZK exchange at Kč 27.00 per euro.
It has maintained the floor in spite of opposition from a populist government which has insisted on letting the koruna float. This undoubtedly would lead to a much stronger koruna, possibly dampening demand for exports further.
The downwardly revised forecast is substantial: from 2.7% annualized rate to a revised 2.3% annualized rate.
Governor Miroslave Singer stated that “...The risk of undesirable second-round effects of foreign cost factors is rising as the duration of the period of very low inflation increases, although those factors primarily represent favourable supply shocks... ...In this context, the board points out that the CNB stands ready to shift the exchange rate commitment to a weaker level if there were to be a systematic decrease in inflation expectations manifesting itself in nominal variables, especially wages...”
Does the CNB have the leverage to raise the floor?
It’s important to keep in mind that the ECB expanded its QE measures last month. EUR/DKK is plotted in light grey over EUR/CZK for comparison. The Danish krone is obligated by ERM II requirements. It reacted with a 0.40% gain on the news, whereas the Czech koruna touched the CNB floor; a 0.17% gain. The CNB is clearly reacting with the same commitment as an ERM II participant.
It was reported that speculators traded against the krone expecting the DNB to ‘opt-out’, but the DNB purchased the weakened krone (at a profit). Might the CNB also undermine trader expectations should the koruna break below Kč 27.00?
In order to get a sense of which way the ECB is signaling, it’s worth noting President Draghi’s recent comments on growth and policy at the 21 April Governing Board meeting.
On rate policy, President Draghi noted that “...We continue to expect them to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases...”
Those purchases are expected to remain in place until at least March of 2017.
The second stated concern was on inflation: “...it is essential... ...to underpin the momentum... ... in order to accelerate the return of inflation to levels below, but close to, 2%...”
The third stated concern was growth: “...real GDP increased by 0.3%, quarter on quarter... ...while being dampened by relatively weak export trends...”
Again, likely due to the slowdown in the Asia-Pacific region; however, US growth seems to have slowed a bit, too. Whether or not this is a ‘one-off’ remains to be seen.
President Draghi noted specifically satisfactory domestic demand, corporate profitability, investment and employment gains as a result of policy but concluded by noting “...The risks to the euro area growth outlook still remain tilted to the downside...”
The last bit of complexity is the upcoming new Czech National Bank governing board, which will begin 25 May. It is expected that Mr. Jiri Rusnok will replace Governor Miroslav Singer. The republic’s President Milos Zeman will also decide whether or not to replace or extend the term of a second voting board member, Kamil Janacek.
It’s reasonable to assume that the sitting board is aligned with the current policy. However, the new CNB governor had held the post of interim Prime Minister under President Zeman as a political ally, but they publically disagreed on monetary policy; Mr. Rusnok favors a weak koruna.
What it seems to add up to is this: The koruna floor is expected to remain in place until 2017; the ECB will likely monitor the effect of its expanded policy for at least two quarters. The incoming CNB governor favors the weak koruna, but has political ties with a government which opposes the policy.
Czech economic growth is very much dependent of EU economic growth, especially that of Germany. Should data show that growth remains muted over the next few quarters, the pass-through effect would be a slowing of Czech growth.
Even with a political ally at the head of the CNB, it would be quite a risk, both economically and politically, to let the koruna strengthen appreciably against the euro.
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