Czech National Bank February meeting unlikely to bring much change, FX floor exit likely by end-Q1 2017

[Correction: Para 1 has been edited to correct "FX floor at EUR/CHF 27" to "FX floor at EUR/CZK 27"]

The FX floor at EUR/CZK 27 is expected to remain in place until the end of the first quarter of this year. After that, it will depend on the Czech inflation dynamic’s development. In the fourth quarter of 2016, the pace of inflation exceeded the projections. It was a surprise for the Czech National Bank, which had expected inflation to reach just 1.3 percent by the end of 2016 and reach the target rate at the turn of 2017/2018.

The sharp rise in inflation attracted major speculative inflows; however, the Czech National Bank appears hesitant to react to this. The CNB might possibly attempt to play down some inflationary factors as only temporary. However, it would have to face the overshooting of the target in most of this year. Therefore, the floor is expected  to be scrapped in the second quarter; however, the central  bank would tolerate slight inflation overshooting and would not give any hikes in 2017, noted Societe Generale in a research report.

The central bank had announced that the board will vote on an exit during one of its monetary policy meetings. According to a Societe Generale research report, the board might vote of it during the May regular session.

“We see a risk that the CNB will call an extraordinary monetary policy meeting in April to remove the floor as soon as its commitment allows. The risk of a later exit is significantly lower”, added Societe Generale.

The exit of the floor is expected to induce a sharp rise in volatility on the foreign exchange market. The central bank would thus be wary while raising its interest rates. Firstly, as the ECB is expected to end its QE program at the end of 2017, hikes might widen the interest rate differential and attract even more flows to the FX market, raising volatility, stated Societe Generale. Secondly, the board of the central bank would want to see the impacts of the floor removal on inflation before further tightening monetary conditions.

The upcoming meeting in February is unlikely to bring much of a change. The central bank is expected to change its forecast in the February meeting. The inflation projection is likely to be raised considerably. However, the bank board is expected to affirm its commitment to keeping the floor at least until the end of the first quarter of 2017.