UNIQA Capital Markets Weekly

USA:
•    Data tracking: March employment report

In March, total U.S. non-farm payrolls increased by 98.000 after rising by 219.000 (revised downward from 235.000) in the previous month (Figure 1). The outcome was below the median estimate among Bloomberg forecasters (180.000). Besides the drop in monthly job growth, the figures of the March employment report were again solid. The average hourly earnings growth was 2.7 % (y/y) after 2.8 % in February and the unemployment rate fell to 4.5 % (after 4.7 %).


CEE:
•    Czech Republic: CNB surprisingly abandoned FX strategy last week after it had become mostly a non-event

At an extraordinary monetary policy meeting held last Thursday, the bank board of the Czech National Bank (CNB) decided to end the exchange rate commitment that it had introduced in November 2013. The discontinuation of the use of the exchange rate as an additional monetary policy instrument means that the koruna exchange rate will move according to supply and demand on the FX market. In the statement, the CNB notes that it stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed.
The exit from the CZK commitment is not a Swiss CHF strategy-exit redux. In January 2015, the Swiss National Bank (SNB) ended its commitment to keep the Swiss franc exchange rate vis-à-vis the Euro at 1.20. Upon announcement, the exchange rate fell to 1.0 and, subsequently, the Euro was around about 15 % weaker. Last week, the immediate impact upon announcement was that the Czech koruna appreciated by around 1.5 % and that the Euro had lost about 1.8 % on Friday (Figure).

One week before the event, in the monetary policy meeting as of 30th March, the CNB had still confirmed its exchange rate strategy. The statement had confirmed the CNB’s commitment to intervene on the FX market if needed to weaken the koruna so that the exchange rate is kept close to CZK 27/EUR. The CNB prevented appreciation by means of automatic and potentially unlimited interventions, i. e. by selling koruna and buying foreign currency. Previously (Board meeting as of 2nd February), the CNB had stated the use of the exchange rate as a monetary policy instrument is assumed until mid-2017. On 30th March the bank board omitted the previous indication about the timing of the exit, thereby giving market participants a signal towards an earlier exit from the commitment. In addition, the statement mentioned that the end of the “hard commitment” was approaching, in turn, signalling the willingness to continue intervening in the FX market if needed after the abandonment of the monetary policy strategy. Hence, the CNB had made it clear for some time now that it is ready to suppress excessive fluctuations in the EURCZK exchange rate following the exit.

In the first two months of the year, Czech inflation increased into the upper half of the tolerance band (+/- 1 percentage point) around the CNB’s inflation target (2 %). In February, the inflation rate was at 2.5 % after 2.2 % (y/y) previously. The CNB staff forecast predicted that inflation would rise above the target this year. However, this occurred slightly earlier and to a greater extent than expected. In addition, the core inflation rate rose faster than previously estimated. Core inflation has been reflecting continued growth in the domestic economy and wages for some time now. The median wage of lower-income employees increased by 6 % (y/y) in Q4 2016 and much more strongly than the average wage.
Last Thursday, in its statement the bank board noted that the conditions for sustainable fulfilment of the 2 % inflation target in the future had been met. “In this situation, continuation of the exchange rate commitment is no longer necessary from the perspective of fulfilment of the CNB’s primary objective of price stability”, the statement said. There is no longer a need to maintain expansionary monetary conditions to the current extent and the exit from the exchange rate commitment is the first step towards a gradual moderation of the expansionary nature of the monetary conditions.

The main policy rates were kept unchanged at the zero lower bound (ZLB). The 2-week repo rate is maintained at 0.05 %, the discount rate at 0.05 % and the Lombard rate at 0.25 %.
The CNB had repeatedly said that the koruna was slightly overvalued versus the Euro before the introduction of the FX strategy. On the other side, the staff projections assume that the CZK would appreciate in the second half of the year and in 2018 amid a positive interest rate differential against the EUR, the effect of the ECB’s quantitative easing and renewed real convergence of the Czech economy to the advanced Euro Area countries. We had previously noted, that the staff forecast includes increases in the CNB’s 2-week repo rate to 0.60 % at end-2017 and 1.20 % in 2018.  This implies further CZK appreciation pressure against the Euro, in particular when market speculations about ECB ‘tapering’ (the step-wise reduction in monthly asset purchases or gradual removal of ‘QE’) are delayed until 2018. Accordingly, the CNB had to escalate FX purchases (weakening the koruna) since January averaging 13.8 bn CZK during the first three months of the year and 17.1 bn CZK in March (Figure 2).
As has been said, the CNB made clear that it would use its instruments to mitigate potential excessive exchange rate fluctuations if needed. We would assume the CNB’s appreciation tolerance for the koruna at 3 % (26.2) to 5 % (25.7) against the EUR and against the previous commitment at CZK 27/EUR. Compared to that, EURCZK forwards currently imply 26.5 by end-2017 and professional forecasters project 26.1 by year-end.



Author
Martin Ertl
Chief Economist
UNIQA Capital Markets GmbH

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