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EURCZK spot and forward exchange rates as well as Czech interest rates went through huge volatility yesterday after the Czech National Bank ended its EURCZK floor mechanism at an extraordinary board meeting.
The EURCZK spot exchange rate even spiked up briefly following the announcement but eventually punched through the 27.00-floor level to end up near 26.60 by European market close.
Leading up to this move, the majority (70%) of market participants surveyed by the CTK news agency had said that they expected CNB to exit within Q2; most expected EURCZK to decline by 2%-4% in the medium-term, but they did not rule out spikes up to 29.00 as short positions unwound.
The much awaited CNB MPC came largely as expected, with the FX floor being kept in place and communication turning more hawkish.
The base case continues to be for the FX floor to be discontinued on May 4 which is a regular policy meeting and in keeping with convention, but acknowledge that an earlier exit is almost as likely.
The medium-term view remains intact—the currency is cheap, activity data is strong and the inflation target has been met, and the combination of which suggests that a slow grind appreciation is likely in the coming months.
However, the main uncertainty is the possibility of an extreme position squeeze in the immediate aftermath of the floor removal.
The EM strategists have published a note outlining their view on this issue.
In their baseline scenario (75% probability) they think the koruna will likely be volatile in contained ranges (26.75-27.25), and thereafter assume a gradual appreciation trend, reaching 26-26.25 by end of the year.
This would involve further upward pressure on local rates, as the koruna will appreciate less than our estimate of the CNB’s macro projections, necessitating further tightening of monetary policy via the rates channel.
They put a 15% chance of a positioning squeeze driving EURCZK to beyond 28.00 and a 10% chance of an even sharper appreciation which would lead the CNB to defend the new implicit floor (which would also include further policy responses such as the possibility of negative rates and a tiering in the CNB’s deposit facility).
Stay short EURCZK forward – sold 26.6883 expiry 27 November 2017.
