LDN - Business

With Czech central bank signaling hike, money market hesitates

[July 26, 2017] By Robert Muller

PRAGUE (Reuters) - The Czech central bank is flagging the first interest rate hike in more than nine years in August or September, but large sections of the market don't believe it.

The view has been that a firmer crown and loose European Central Bank policy will stay Prague's hand -- a notion central bank watchers and analysts reckon means local money markets are underpricing the chance of a Czech hike.

However, with the Czech economy on pace to grow around 3 percent this year and next, inflation above target, Europe's lowest unemployment pushing up wages, and house prices soaring, there are solid arguments for a hike.

That makes the crown's exchange rate -- freed from a cap in April -- the only key variable that may push the first interest rate hike to a later date.

The bank has made the importance of the exchange rate clear and has sent varying signals in the past months as the currency's appreciation pace fluctuated.

"With a stronger crown you don't have the urgency to tighten," Aberdeen Asset Management portfolio manager Viktor Szabo said. "We are still seeing (crown) appreciation, so for the time being it looks fine."

The Czech National Bank (CNB), though, hinted after its June meeting that a hike -- the first one in the European Union in five years -- is near, indicating the third quarter.

This has persuaded some analysts, but not all.

The crown <EURCZK=> got a boost last week after Bank of America Merrill Lynch (BofAML) tipped a rate rise for the Aug. 3 central bank meeting. It firmed briefly past the psychological 26 per euro level for the first time since it was set free and is now 3.8 percent stronger than its former cap.

"It is a close call on timing, but it is just a matter of months for the hikes to come," BofAML said. "Markets continue to underprice the CNB's near-term tightening prospects."

Forward rate agreements <CZKFRA> <PRIBOR> have risen in the past week but mostly on longer maturities, giving little chance to an August move and not fully pricing a September hike.

This reflects the general situation on global markets, analysts say.

"(Investors) don't believe central banks can raise rates so soon," J&T Banka economist Petr Sklenar said. "The risk is if central banks (do) increase interest rates in the United States and the Czech Republic, there will be a period that the market will need to re-price in a short period."

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A sign of a currency exchange office hangs in front of the Czech National Bank in Prague November 14, 2013. REUTERS/David W Cerny

CROWN CONUNDRUM

Weighed down by long positions built up by investors, the crown was slow to appreciate out of the gates after the cap was lifted.

Faster gains, however, reduce the need for interest rates to rise so quickly from near zero, where they have been since 2012. Reflecting this, crown gains prompted policymakers to say in early June that the appreciation could delay a rate hike to the fourth quarter. The crown retreated after those comments.

But the central bank then said after a June 29 policy meeting a third-quarter rate hike was likely if the bank's economic forecasts were being met.

"All the data confirm our forecast assumptions and that applies both to the exchange rate and, of course, also other macroeconomic indicators," Governor Jiri Rusnok said then.

"And in this context, we reached the conclusion that if all parameters of the outlook are fulfilled, then also the step (of) raising rates, detaching rates from zero, has to be met."

That has led the crown to gains of more than 1 percent. The central bank declined on Wednesday to comment on market pricing or the crown.

The result, analysts say, is investors left guessing how serious the central bank is on moving rates, ahead of others in Europe.

Many still believe crown firming will do the bank's work. Some also say the central bank may not move until it is clearer when the European Central Bank will put an end to its ultra-loose policy of buying bonds from the market.

But that could leave many wrongfooted.

"The risk is more toward a hike in Q3, but it is not a hundred percent," Komercni Banka rates trader Dalimil Vyskovsky said.

(Additional reporting by Jason Hovet Editing by Jeremy Gaunt)

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