Czech National Bank is set to keep FX floor at least until mid-2016

The Czech National Bank meeting did not deliver any monetary policy change, as expected. During his speech, the Governor of CNB did not comment on the exchange rate movement at all; nor did he discuss pressure on the FX floor seen in August/early September and the current move further from the floor. Risks to the current forecast were clearly labeled as anti-inflationary owing to lower food and fuel prices stemming from world price trends. This is offset by the performance of the domestic economy. Since the inflation outlook does not offer any significant upside risk, the CNB aims to maintain its loose monetary policy, keeping the FX floor regime until at least mid-2016.

During the post-meeting press conference, Governor Singer presented the board's statement, with the CNB stating that the inflation is lagging behind the forecast and that the target would not be met next year. The central bank mentioned that it was surprised on the upside by the strong Q2 15 GDP growth. The reason the forecast was off by one percentage point was due almost exclusively to inventories. Nevertheless, economic activity is broad based across the expenditure components, and value added is picking up as well. Governor Singer explicitly mentioned that the solid development of monthly indicators points to strong growth in Q3. Industrial production has accelerated since April, construction is growing at a double-digit pace and retail sales are rising as well. This economic growth is improving the labour market situation. Employment has risen, with the number of vacancies almost doubling as compared to the previous year. Wages growth in both the non-business and the business sector has taken place.

However, in spite of continuing growth in the euro area, forecasts of price development are muted. The outlook on producer prices for the remainder of this year and the first half of 2017 has been revised down. Even the base effect of energy prices should not trigger growth in this price segment. Additionally, the outlook on consumer prices in the euro area has been revised down slightly, but is still gradually rising towards the of 2% target.

As a result, the CNB has decided to hold its FX floor policy and reiterated that the exit would not take place before mid-2016. The board stated that, "the Czech National Bank still stands ready to intervene automatically, i.e. without the need for an additional decision of the Bank Board, and without any time or volume limits." On top of that, the Governor stated that "According to the forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will not occur until early 2017." The reason for this is the currently low inflation environment. The CNB was surprised on the downside and even the outlook for inflation based on the last forecast brings consumer inflation to the target only at the end of the next year.

"We are surprised that the CNB did not comment on exchange rate development. The Czech koruna has depreciated further from the FX floor over the last couple of days, which does not strengthen inflationary pressure on the Czech economy. We expect inflation to reach the 2% target as soon as mid-2016. We thus we see no reason for a shift in the FX floor to weaker CZK levels (except in the case of a really exceptional situation). The CNB should therefore exit the intervention regime in Q3 16 and start the hiking cycle in early 2017 when inflation hits the CNB's target according to CNB's forecast", says Societe Generale.