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Rising inflation underpins Czech National Bank's crown cap exit

Rising inflation around euro zone has intensified speculation that Czech central bank (CNB) will terminate its FX cap earlier than the currently scheduled mid-2017. After undershooting the central bank's 2 percent goal, Czech Republic's annual consumer-price growth quickened to 1.9 percent in December following an unexpected jump to 1.5 percent in November.

CNB board members are however sounding words of caution as they realise that the inflation acceleration is mainly driven by commodity prices. CNB deputy-governor Vladimir Tomsik remarked recently that it is not sufficient for inflation to simply hit the 2 percent target before CNB abandons its intervention policy; he stressed that the board would have to feel convinced that this was happening in a long-term, sustainable manner. The view was echoed by Governor Jiri Rusnok.

"We ourselves are not convinced that euro zone core inflation is accelerating sustainably – hence, we stick with our base-case that the FX cap would be maintained until the end of 2017. But, we acknowledge that the risk of earlier exit has increased significantly over the past month." said Commerzbank in a report.

Speculation about exit from crown cap and subsequent rise in the currency has also fuelled demand for Czech government bonds despite their ultra-low yields. The yield on the two-year Czech bonds dropped 6 basis points to a record low of -1.166 percent.

"We expect the CNB to continue to guide markets towards an exit of the floor by mid-2017 to avoid any speculative pressures on the floor, but we expect an earlier removal of the floor if speculative pressures increase substantially," analysts at Goldman Sachs said in a note.

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