Europe’s Most Reliable Rate-Hike Beacon Goes Dim

(Bloomberg) -- Weakness in the Czech currency has reliably pointed the way to the longest run of interest-rate increases in Europe. But at their last meeting of the year, policy makers may opt for a pause, even as the koruna continues its slide.

The country’s assets are heading for a period of seasonal price swings as banks shrink their balance sheets for regulatory reasons before year-end. While the same happens in other European countries, the moves are magnified in the Czech Republic because its markets are awash with koruna liquidity from the central bank’s currency-intervention regime, which ended in 2017.

“The koruna’s expected weakness in the coming weeks would, technically, open room for a December rate increase,” said Jakub Seidler, chief economist at the Czech unit of ING Groep NV. “But it now seems more likely policy makers will wait for the year-end effect to peter out before they act again,” he said.

What causes the year-end swings?

Czech banks’ payments into a deposit-insurance fund depend on the size of their balance sheets as of Dec. 31. That means they have an incentive to briefly shed liabilities that day by imposing deeply negative rates on some large deposits. This prompts investors to switch into other financial instruments or a different currency.

What’s the impact on the koruna?

The steep drop in short-term market rates temporarily reduces the appeal of the Czech currency. ING expects the koruna, which traded at 26.05 per euro on Tuesday, its weakest level in more than four months, to remain under pressure in the next six weeks and test 26.18.

Read more on investors’ positions in the Czech koruna

The koruna has already fallen 1.6 percent in the past six months, more than peer currencies in Hungary and Poland. It’s held back by global emerging-market jitters and headwinds from a gradual unwinding of oversized long position.

What’s the impact on monetary policy?

Central Bank Governor Jiri Rusnok said on Nov. 9 that the year-end market distortions obscure the currency’s outlook and the central bank “can easily wait” with further rate increases after lifting borrowing costs five times this year.

The koruna has defied central bank expectations for appreciation this year, failing to deliver the monetary tightening required to cool the economy. Policy makers, who estimate that a 1 percent koruna gain to the euro has roughly the same effect as a quarter-point rate increase, have therefore been forced to accelerate hikes.

Viktor Zeisel, an economist at Komercni Banka AS in Prague, expects the benchmark to stay at 1.75 percent in December, while he forecasts three increases next year to 2.50 percent. That compares with the policy makers’ projections for broadly stable rates until 2020.

“They will probably see through the year-end effect and wait for the exchange rate to settle in early 2019,” he said. “We then expect they’ll have to start hiking again because the koruna simply won’t gain as much as they think.”

To contact the reporters on this story: Krystof Chamonikolas in Prague at kchamonikola@bloomberg.net;Marton Eder in Budapest at meder4@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, ;Dana El Baltaji at delbaltaji@bloomberg.net, Alex Nicholson, Peter Laca

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