Beware of the crown

It is not long ago when we were writing that it wouldn’t be surprising if CNB had to push more money to the interventions in the second half of the year than it did during the entire intervention time. Really – the situation is starting to get more dramatic even though it is not visible from the outside. According to the unconfirmed news based on the interviews with bank dealers, it seems that during past two days CNB had to withdraw so many euros from the interbank market as it did in entire August. Or in the other words: The intervention regime is starting to get more expensive. To put it even differently: Pressure on Czech crown to appreciate against the euro is significantly growing. Speculative pressure. It is not the kind of pressure coming from the title of foreign trade or even direct foreign investments (like it was before). It is a pressure that is rooted in the fact that more and more subjects are betting on the upcoming moment when CNB – simply said – “won’t have the strength” to artificially keeping crown’s exchange rate by interventions and it will let it spontaneously appreciate.
The amount of money that was put into interventions was growing for quite a while, with the beginning of summer it started speeding up and now it’s escalating. Technically said if the CNB wants to keep the crown above the 27 CZK/EUR it has to keep buying bigger volumes of euros from commercial banks and paying them with crowns.
That causes two things. Firstly, forex reserves in euros on CNB’s accounts are blowing up gigantically. (When the CNB really lets the crown appreciate these forex reserves will deteriorate sharply which will be basically the cost or “the price” of the interventions.) Secondly, more and more free crowns are getting into the circulation. Commercial banks are having more and more Czech cash that they don’t really care for. That has a similar effect like the politics of European central bank (ECB) which is pushing more euros into the circulation via buyout of bonds. If there is too much cash, which the banks don’t want, the “price” of this cash is dropping or the interest rates are dropping in the entire economy. We do not have to worry that the banks would charge their clients negative or actually vindicatory interests like in Eurozone but we are getting closer and closer to this situation. Just like in the Eurozone there is simply too much money among banks in the background. (This is right place to also mention, just to be accurate, that there are some tools, specifically so-called sterilization that can help to compensate this influence on the interest rates but either way that can never work 100 %.)
Both described effects are a technical problem rather for CNB then for households or businesses at this point. That doesn’t mean that we shouldn’t be interested in it. The joke that if CNB has to face both and the escalating undesired effects of the interventions on top of that it is harder for CNB to apply the interventions. The experience of other central banks from around the world is showing that one day – a much unexpected day – a moment can come when the central bank will not be able to keep the intervention regime anymore. (Or more precisely it would be able to hold the regime but at cost such high that it simply won’t be profitable and it has to resign on the exchange rate.) We can think of similar case from the Switzerland from not long ago or very known case from Britain which happened a while ago when the British central bank had to “quarrel” about the exchange rate with the speculator Soros. Soros won that time and the central bank had to capitulate. I don’t like pointing this out but the British central bank is somewhat bigger than the Czech one…
Inconspicuous signals are pointing out that in the Czech Republic this moment of truth hypothetically doesn’t have to be that far away. Until now the CNB was claiming that the intervention regime should stay valid approximately until the half of 2017. “Suddenly” it is coming with surprising statement: According to the governor Rusnok, the CNB could hypothetically want to hold the crown above the level of 27 CZK/EUR with the help of interventions even in the second half of 2017. What a shocking twist of events that this statement comes exactly in the moment when the pressure on CNB to appreciate the crown is significantly growing! It has an easy explanation. If the speculators believed that the intervention regime will really stay even until 2017, it wouldn’t be worth it to speculate about crown appreciating now. They would end their speculations and the speculative pressure on CNB would cease. So, the CNB could without bigger expenses keep its intervention regime.
In reality, we need to read statements of CNB upside down: The more ambiguously CNB talks about the interventions and the later it’s admitting their end, the risk that the intervention regime will be left much sooner, without a warning and the crown will appreciate sharply, is growing. At this point, it is hard to say if it’s going to happen or not, it depends on the ratio of speculative bets against the crown (on the one side of scales) and the will of CNB to go beyond and “fight” with the market (on the other side of scales). Both is highly subjective matter. Important is that we can’t 100% rule out that CNB could as a last resort be forced by circumstances to leave the intervention regime this year.
Artificially weakened exchange rate was very pleasant for the Czech exporters for three years. Now the risk that the situation will turn around is growing. The rapidity of this turnaround which could crushingly hit the exporters is precisely the reason why we were during those three years very critical of the intervention…Their positive effect could hypothetically be more than annulated. The exporters shouldn’t hesitate to secure themselves against the appreciation. However, might the forward (secured) exchange rate seem to be expensive, it is probably still more convenient than the exchange rate we will get after we leave the intervention regime – especially if this situation intensifies.
Then there is one more risk which seems to not be related to the exchange rate. The interest rates. Another thing that could happen is that the CNB won’t be willing to capitulate under the pressure of speculators but the pressure remains huge. Theoretically, there is one way out of this and that’s implementation of the negative interest rates. There are two hitches in it. First is that known opponents of negative interest rates are sitting in CNB’s bank board. Second is that for negative interest rates to work they would have to be really negative to discourage the speculators, even more then they are in the Eurozone. That means -0.75 %. And that is big shock for the economy, which would surely manifest in negative interest rates for bank clients as well. It is hard to say what the bank board would consider lesser of evils: sharp appreciation of crown or blanket and deeply negative interest rates. Either way, the time of changes in Czech currency politic is coming even when it doesn’t seem that way from the outside.