CNB Rusnok: Can’t Exclude Weaker Koruna Accelerating Normalization

16th May 2018

By David Barwick

(PRAGUE) – A weaker-than-projected Czech koruna that speeds up the Czech National Bank’s efforts to boost interest rates to a more normal level can’t be excluded, even if this is not monetary authorities’ central scenario at this point, CNB Governor Jiří Rusnok told ITC in a recent interview.

Indicative of the bank’s reasonably relaxed approach to tightening, only one of the seven members of the CNB’s rate-setting board voted at the last policy meeting on May 3 to hike the key two-week repo rate by 25 basis points from its current level of 0.75%, where it has been since being increased by 0.25 last February 2.

The prevailing view at the CNB that this year would see only one more rate hike and that this would come in 4Q is at odds with the opinion of some analysts who see two more upward moves between now and the end of 2018, for a total of three this year.

A crucial policy variable is the strength of the koruna. Following a very robust performance by the currency last year versus the euro and especially the dollar, the consensus is for a slowdown in the pace of appreciation this year, a view borne out so far.

By the end of the current year, the CNB is expecting a euro exchange rate of 24.6 koruna. That compares to about 25.5 as of Tuesday.

Rusnok reiterated his standpoint that “a further hike should occur sometime towards the end of the year, that is, in Q4,” assuming developments proceed as expected. The insistence of some observers that one more hike would not suffice for 2018 suggests that they “expect that the koruna will be weaker than it is in the assumptions of our forecast and that room for a faster interest rate increase than in 2018 Q4 will thus be created.”

“That certainly can’t be ruled out,” he said.

Even two more hikes of 25 basis points apiece to the two-week repo rate would leave CNB policy well below the range of 2.50% to 2.75%, which Rusnok called “roughly” equilibrium.

“However, the question is whether this is realistic given the current circumstances in the global and Czech economy,” he said. “I regard the achievement of such a state next year as rather unlikely now. Nonetheless, we should certainly get much closer to that level.”

Rusnok did not appear to see the currency’s general strength as any cause for concern, arguing that “the koruna’s appreciation over the last year or so has not deflected the Czech economy and its competitiveness from its previous equilibrium.”

In any case, with the narrowing of the gap between the koruna’s fundamental value on the one hand and its market valuation on the other – which partly reflects the exchange rate commitment only terminated in April 2017 – “the strengthening of the koruna will gradually slow and should later only reflect the level of real convergence towards the euro area core and any difference in price levels,” he said.

Although one CNB board member recently expressed the opinion publicly that the balance of risks to Czech inflation is to the upside, “those [board members] seeing the near-term outlook as slightly anti-inflationary and, in particular, balanced, distinctly predominated,” Rusnok said, which is why this was the tenor of the board’s overall assessment.

“I agree with that assessment” of balanced risks, he added. Moreover, he noted, the bank’s current stance means it is in a “much better” position to deal with higher inflation than with lower.

Rusnok said the sense at the spring meetings of the International Monetary Fund and World Bank was one of “moderate optimism” that the current “solid growth” seen globally “should continue in the years to come.”

He endorsed the IMF’s appeals to policymakers to strengthen economic resilience, and noted that “too-rapid monetary policy tightening by key global monetary authorities” was among the biggest sources of uncertainty mentioned.

Protectionism is a further “very serious” threat, he said. “I understand that the USA may feel, due to historical developments, that it is in an ‘unfair’ position as regards the level of symmetry of protection of its own market, for example in relation to China or other large, economically strong countries and groupings.”

Multilateral negotiations are the proper way to address this, not unilateral trade barriers, he warned, which “cannot go without a response and may trigger a very dangerous spiral which will ultimately harm everyone.”

Rusnok sounded more optimistic with regard to Brexit, despite its potentially relatively large indirect danger to his economy. “I don’t see this too dramatically,” he said. “I believe that it is in the interests of both sides to reach a pragmatic agreement.”

He soundly rejected the idea that the Czech Republic was flirting with political authoritarianism that could threaten the autonomy of his own institution.

“The CNB’s position is exceptionally independent and strong in the European context and is effectively guaranteed by the Constitution,” he said. “I’m convinced that our independence is more robust than in many other traditional Western countries in this respect … The central bank’s independence is definitely not in jeopardy in the Czech Republic.”

In other comments, Rusnok expressed understanding for his fellow Czech citizens’ hesitancy about adopting the euro, arguing that the koruna and its predecessor currency had “provided a great deal of certainty for them over the entire democratic period, that is, in the past 30 years.”

Czech inflation has generally been low, rarely double-digit and indeed for many years below the level of the euro area, he said. In addition, Czech consumers were spared the drawbacks of foreign currency mortgages, he noted, and economically the country has fared well with its own currency.

He continued: “The euro area is now different from how it was before the crisis. Its design has turned out to suffer from numerous defects in bad times. If the project is to be sustainable, those defects will have to be remedied. This is being worked on, but it’ll probably take a long time to reach a satisfactory position. That’s why I believe that our joining the euro area is not an urgent matter. I don’t even see it as a topical issue in the next ten years.”