CZK meltdown: Is the past catching up?
Given the global backdrop, EUR/CZK is set to head higher, with EUR/CZK 26.50 being the next realistic target. With the koruna under heavy pressure, potential aggressive rate cuts could make things even worse and generate a CZK meltdown. We thus refrain from a call for meaningful CNB rate cuts, though a modest signalling rate cut seems more likely for now
CZK under preassure
The Czech koruna is sharply down and EUR/CZK is above 26.00. What used to be the safe harbour in times of stress within the CEE region has turned into an underperformer.
The problem for the koruna is that positioning is finally catching up. Foreign holdings of Czech government bonds - behind 40% clearly shows that the koruna has been persistently and chronically overbought, making it vulnerable in times of stress. While the CZK weathered the 2019 global trade war storm relatively well (EUR/CZK did not move above the 26.00 level), current market jitters are taking a heavy toll.
This is due to:
(a) Across the board deleveraging, which has made overbought currencies particularly vulnerable (CZK in the CEE, RUB in the wider EMEA space or MXN in the LatAm region),
(b) Markets aggressively pricing in Czech central bank rate cuts, with the central bank being one of the few with ample room to ease monetary policy.
Potential rate cuts will affect CZK
While there isn’t much the Czech authorities can do about the positioning, they have power over rate cuts. Although from a bird's eye view, the case for central bank rate cuts is rising, from an idiosyncratic point of view, any larger scale easing cycle would in our view lead to a CZK meltdown.
The currency is already very vulnerable due to the positioning and should the central bank take away the key anchor behind CZK (the yield advantage), the exodus from Czech asset markets could be rather pronounced. Indeed, based on our conversation with investors last year, the yield advantage was the key reason why investors remained invested in CZK during the 2019 global trade war.
Signalling CNB cut more likely
Bar the implications for the currency, we also don’t see rate cuts as the best remedy for the current Czech economic situation.
A more effective measure would be a lower counter-cyclical capital buffer to support credit availability
As Governor Jiří Rusnok mentioned this week, rate cuts might not help the economy much as a small deceleration in lending costs won’t be a game-changer for companies, which mainly need to have access to credit. Credit availability will be considered as more crucial than lending costs itself.
A small rate cut would aim to signal coordination between the central bank and the government (as was the case in the UK), but a more effective measure would be a lower counter-cyclical capital buffer to support credit availability.
Hence, we are biased not to call for aggressive easing from the central bank given the currency consideration. Of course, with the central bank having ample FX reserves (60% of GDP), it is well equipped to deal with the currency free-falling, if the situation were to arise and defend the koruna.
We think FX interventions below EUR/CZK 27.00 are unlikely
But we think FX interventions below EUR/CZK 27.00 are unlikely. To be clear, the current CZK fall is primarily a function of the global environment and pressure on risk assets (including EM FX) and the central bank cannot do much about it, but there are idiosyncratic reasons why the CZK declining more than its CEE peers and here the CNB has the power to influence the scale of the koruna downside.
It's worth noting that the CZK weakness has already delivered three implicit rate cuts, while the koruna is still not undervalued after the recent fall.
Download
Download article13 March 2020
In case you missed it: Pandemic pandemonium This bundle contains {bundle_entries}{/bundle_entries} articles"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.
This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.
The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.
Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.
ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).