The Czech central bank headquarters in Prague. The bank has said it will maintain the currency cap until at least the second half of 2016.

Reuters/Prague

The Czech crown may test its cap against the euro, although there is little appetite for a serious challenge of policymakers’ resolve any time soon given the small market and the central bank’s ample scope to intervene.
The bank introduced the cap in late 2013 to fight deflation risks, pledging to keep the crown weaker than 27 to the euro. It has said it will maintain the cap until at least the second half of 2016.
When Switzerland abandoned its currency peg in January, markets’ focus shifted to other currencies that were linked to a rapidly weakening euro, notably the Czech crown and the Danish currency.
The launch of the European Central Bank’s quantitative easing programme last month has also boosted interest in emerging European assets, and the Czech crown firmed to as high as 27.14 to the euro on March 17.
However, there was no strength in the move, and the crown is back in a range around 27.50.
All 12 analysts in a March 24 Reuters poll said they expected an eventual test of the cap. At this point, though, it is more likely to come from corporate flows, such as hedging by exporters, in a thin market.
Dealers and fund managers say it is too soon for any concentrated effort to beat the Czech central bank – whose foreign reserves are low compared to Switzerland’s.
A serious attempt is probably unlikely until inflation begins to rise, in other words only when the bank is close to exiting the policy.
An economist at a London-based bank, who asked not to be named, said that after the Swiss dropped their cap on January 15 he fielded several calls from hedge funds expecting the Czechs to follow suit. Big money investors have since thought twice.
“Interest has completely faded,” the economist said.
“The Swiss increased their reserve holdings 10 times, they had to intervene so much - and that is when they lost it. So there is just an awful lot of stuff in the way before the Czech National Bank is going to let this go.”
The bank may not need much to repel an accidental breach. When it launched the policy, it bought €7.5bn over a few days to weaken the crown by about 6.5%. It has not stepped into the market since, letting the crown float freely on the weak side of 27 to the euro.
The bank has made clear that it will keep its intervention policy until inflation – now near zero – is firmly headed to its 2% target.
After a policy meeting on March 26 Governor Miroslav Singer said the bank could adjust the cap to a weaker level if necessary, and the bank stressed that interventions would be automatic and limitless if needed. Minutes from the meeting showed policymakers have not ruled out other unconventional tools.
There are several reasons the bank could withstand any currency attack. First, it can in theory print as many crowns as it wants to buy euros. It has reserves worth €48.7bn, or 30% of economic output – versus 80% in Switzerland.
The market is also small, with daily spot trading volumes around 92 times smaller than in Switzerland and 50 times smaller than in Denmark, according to the Bank for International Settlements.
The thin market would make it difficult to unwind larger bets.
CSOB analyst Jan Cermak said the ECB’s bond buying could lead to a challenge on the cap later this year, but even if it does the Czech national bank could defeat it.
“The test ... could easily happen later this year because inflows coming from the euro zone... (are) so huge,” Cermak said.
“It will be easy to defend... by less than €1bn to move EUR/CZK higher in this small market.”
In the meantime, analysts say a weaker cap level or even negative interest rates are possible.
In January, the crown hit a six-year low on concerns the bank may weaken it and the central bank is still on alert for second-round effects on inflation from the slump in global oil prices.
Policymakers may be reluctant to weaken the crown further, though, as the interventions in 2013 generated a strong public backlash as it made imports and holidays more expensive, and President Milos Zeman is a fierce critic.
The consensus in the March 24 poll was that the bank will exit its policy as scheduled. However, markets may take a different view if the Czech economy, which grew 2% last year, is stronger and analysts view the policy could be shortened.
“People here know the central bank will keep (the cap) for at least a year,” a Prague-based dealer said.
“If the (data) environment is more likely pointing to a stronger crown, then it is a good time (for a test) ... I don’t think the trigger should be pushed yet.”