Czech Koruna:1-3 Month Outlook

In the past month, EUR/CZK has hit its lowest level of 27.006 since November 2013. CNB has intervened on the FX market for the first time since it established the 27.00 cap in November 2013. 

CNB confirmed that it intervened on July 17, and we believe it may have intervened thereafter as well to defend the floor. Back in November 2013, CNB had intervened on the FX market by selling ~EUR7.8bn to defend the floor and weakened the koruna against the euro by ~4.5%. 

"CNB is expected to remain committed to its koruna cap until inflation reaches its 2% inflation target, which CNB forecasts to occur in Q3 2016. Inflation has been slowly picking up for the fourth month in a row. June CPI y/y came in at 0.8%, compared to market consensus of 0.9% and May CPI y/y of 0.7%", notes RBC Capital Markets.

A stronger koruna and lower oil prices in the past month may have increased deflationary pressures. Additionally, market consensus for headline inflation in Q3 2016 currently stands at 1.80% y/y, which is below CNB's 2% forecast, adds RBC Capital Markets.

Early removal of the koruna cap may jeopardize CNB's reputation. After SNB's unexpected decision to pull the peg in January, CNB may look to avoid a nontransparent decision to remove its cap. RBC Capital Markets assumes, it is in CNB's favor to buy FX to cushion its external debt. Based on annualized Q1 nominal GDP, international reserves stand at 32% of GDP. The ratio for total external debt is twice that, at 65% of GDP. Short-term debt is 84% of reserves.