Czechs Signal Pause in Rate Hikes and Bet on Stronger Currency

(Bloomberg) -- The Czech Republic, the European Union’s quickest country to raise interest rates, signaled it won’t rush to increase borrowing costs much more this year because a stronger national currency will help cool the economy instead.

After delivering its third rate increase in six months on Thursday, lifting the benchmark to 0.75 percent, central bank Governor Jiri Rusnok said only one more hike was likely this year. In addition, it revealed its outlook for the exchange rate for the first time in more than four years, suggesting rapid koruna appreciation.

“In this view, koruna appreciation tightens monetary conditions sufficiently, and thus significantly lowers the need for another interest-rate hike,” said Jiri Polansky, an analyst at Erste Group Bank AG’s unit in Prague. “In 2019, the central bank expects a relatively significant pace of monetary tightening, mainly via interest rates.”

The bank’s seven-member policy panel is trying to find a balance between raising rates and a stronger koruna to temper consumer price growth that’s running above target as a shortage of workers drives salaries higher in the country of 10.6 million people. Buoyed by export-oriented manufacturing industries and expectations of further policy tightening, the Czech currency has rallied the most worldwide since last April, when the central bank ended a Swiss-style cap on its appreciation.

Regional Deviation

In eastern Europe, the Czech Republic and Romania have departed from regional peers who’ve committed to standing pat on policy as the European Central Bank continues to twin its quantitative easing program with ultra-low rates. In neighboring Poland, central bank Governor Adam Glapinski has pledged to keep rates stable this year, while Hungary held benchmark borrowing costs unchanged Tuesday after deploying a new battery of unconventional easing measures.

The Czech central bank sees the koruna at an average of 24.9 a euro this year, before appreciating to 24.5 in 2019. It trimmed its first-quarter 2019 inflation outlook to 1.9 percent from 2 percent and raised this year’s economic-growth projection to 3.6 percent.

This year’s expected exchange-rate strengthening reflects the widening gap between Czech and ECB interest rates, Rusnok told reporters Thursday. Further appreciation momentum will come from economic growth outpacing the euro area, and increasing labor productivity, he said.

Even so, the central bank may be too bullish on the koruna, namely its anticipation of a gain of almost 2 percent between the first and the second quarters of this year, according to Jakub Seidler, chief economist at ING Group NV’s Czech unit.

“Since the central bank’s projection appears to be relatively optimistic, and the koruna may in the end strengthen at a slower pace, especially in the second quarter, we still see room for two more rate increases this year,” Seidler said. “The precise timing will depend not only on data coming from the economy, but also on exchange-rate developments.”

--With assistance from Marton Eder

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net, Krystof Chamonikolas in Prague at kchamonikola@bloomberg.net.

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, Andrew Langley, Tony Halpin

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