Koruna Loses Appeal as Broken Market Blunts Record Premium
(Bloomberg) -- Once embraced as a haven asset among emerging markets, the Czech koruna is turning into a headache for investors and policy makers.
These days, the currency dances to its own tune, weakening despite an unprecedented string of interest-rate hikes and mantra-like predictions of strength from the central bank. A year ago, analysts forecast a 3 percent rally. It never came, and now Raiffeisen Bank International AG, ING Groep NV and JPMorgan Chase & Co. have all switched to betting on further depreciation.
“The koruna market isn’t working properly and the currency has lost its safe-haven status,” said Helena Horska, chief economist at Raiffeisen’s Czech unit.
Call it the curse of the cap. From 2013 to 2017, the Czech National Bank kept the exchange rate artificially weak to escape deflation and bolster the export-driven economy. Knowing the policy wouldn’t last forever, and betting the koruna would jump once the intervention regime ended, foreign investors piled in, with many scooping up as much as their risk managers would allow them. And the rally did happen: the koruna was the best-performing major currency worldwide in 2017.
But a year on, trade wars and Brexit are preventing further appreciation and the currency is paying little heed to the central bank’s run of rate hikes aimed at stemming inflation. The exodus is playing out in slow motion as a dearth of koruna buyers bedevils foreign investors’ efforts to unwind the tens of billions of euros bet on the local currency.
“It no longer makes sense to buy the koruna, as holdings are dominated by big foreign players who follow global sentiment rather than Czech fundamentals,” said Horska, who predicts another 2 percent depreciation by year-end. “If anything, they will be thinking about when and how to exit the trade.”
Read more about how the defunct currency cap keeps affecting Czech markets
The extra return offered by local interest rates over those in the euro area has never been bigger and Czech government bonds are yielding more than in lower-rated Portugal. But that’s not enough to cure the weakness. Even though policy makers raised borrowing costs last week for the sixth time since the start of last year, the koruna fell because the central bank didn’t commit to further hikes.
While the monetary authority insisted its latest economic forecasts reflect the koruna’s past inability to strengthen, they still assume an appreciation of about 3 percent by year-end. That’s more bullish than any projection in a Bloomberg survey of more than 20 analysts.
The gains won’t materialize, making another rate hike likely in the second half of the year, according to Societe Generale SA, which has been warning that policy makers may grapple with a weak exchange rate for decades after the removal of the cap.
After a string of misses, the central bank has developed a new system to improve the accuracy of forecasting variables including the exchange rate, household spending, and the impact of price developments abroad. It plans to start using the tool, known as G3+, in the second half of the year.
But a document published by the monetary authority on Friday indicates that, if applied today, G3+ would produce very similar outcomes, projecting only cosmetically slower koruna gains than the currently used model.
“The central bank still assumes that the interest-rate differential should make the koruna attractive and hence fundamentally stronger over time,” said Viktor Zeisel, a Prague-based economist at SocGen. “But the link between rates and the currency is broken. The huge positioning will keep hampering koruna gains.”
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