FxWirePro: CNB to normalize monetary policy - Uphold EUR/CZK shorts in forwards of far-month tenors

The CNB’s new staff forecast and communication mix sent a more dovish signal than anticipated. This included a downward shift in the projected inflation path, a lower path of market rates “consistent with the forecast,” the admission that the ECB’s QE will “strongly dampen” domestic rates, and Governor Rusnok stating that there is no urgency to tighten monetary policy.

However, the risks to the CPI forecast were characterized as “slightly inflationary,” suggesting the potential for a shift in the CNB’s bias if EURCZK remains glued below 27.0. We expect the first rate hike in 1Q18, assuming EURCZK reaches below 26.25 at end-2017.

We remain bullish on the koruna following the removal of the currency floor on 6 April. EURCZK has exhibited low volatility following the floor removal, which we expect to continue in the near term. However, a gradual CZK appreciation path in the months to come is likely to be established:

1. The CNB is likely to begin monetary policy normalization. The CNB is likely to begin monetary policy normalization:

JPM expects the first policy rate hike in 1Q18 (+20bp to 0.25%), but risks are that the market begins to price normalization to begin in earnest already in 2017, despite the CNB taking a more dovish tone at its latest Bank Board meeting on 4 May.

2. Medium-term valuations are supportive:

CZK is around 5% undervalued based on our BEER and FEER models. While the already long CZK positioning may prove a hurdle for short-term appreciation (the latest JPM Client Survey shows investor longs remain at record highs), we think the currency will find support from a central bank that is gradually turning hawkish.

We continue to hold short 27-Nov-17 EURCZK forwards.

We revise our end-2017 EURCZK forecast up to 26.25, given the lower than expected volatility of the currency post floor removal.