Europe's Rate-Hike Pioneers Have Market's Attention Again

(Bloomberg) -- The Czech Republic is back on investors’ radar as a prime candidate for another increase in interest rates this year.

After watching policy makers in Prague take the lead in Europe’s turn to monetary tightening with three hikes between August and February, derivatives markets swung to skepticism that they will raise borrowing costs again this year. But traders are now piling into bets that another increase will come within six months after an inflation revival in April added to the surprisingly hawkish resolve on display at last week’s policy meeting.

Forward-rate agreements, used to bet on future changes of borrowing costs, now show investors pricing in an increase in the benchmark to 1 percent by November, from the current 0.75 percent.

“The central bank’s more hawkish tone last week and the data showing slightly higher inflation are strengthening investors’ conviction that there will be another rate increase this year,” says Dalimil Vyskovsky, chief fixed-income trader at Komercni Banka AS. “Previously, the market priced in no hike before spring 2019.”

Although the central bank left borrowing costs unchanged for a second meeting on May 3, it said that more tightening is in store this year for the Czech economy, one of Europe’s fastest growing. That should come mainly by way of currency appreciation and possibly also a rate hike near the end of the year, according to the bank’s fresh staff forecast.

Read more on the central bank’s policy deliberations at its meeting in May

The exchange rate plays a key role in the timing and the pace of future rate increases. Czech central bankers want to avoid an excessive widening of the gap with rates in the euro area since that could strengthen the koruna too much after it was already the best performer among major currencies in the past 12 months.

European Central Bank stimulus will also remain a barrier for faster Czech hikes, the monetary authority in Prague said on Friday in minutes of its May 3 policy meeting.

To appreciate how carefully the central bank needs to manage market expectations about its policy outlook, the release of April inflation on Thursday offered a case in point. Aided by the faster-than-forecast price growth, the koruna gained 0.4 percent on Thursday. It was little changed at 25.47 per euro on Friday as of 9:30 a.m. in Prague.

The central bank’s forecast assumes the koruna strengthening to an average 24.6 per euro in the last three months of the year, or nearly 4 percent stronger from current levels.

©2018 Bloomberg L.P.

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