MNI CNB Review - August 2023: Cautious Dovish Pivot Underway

Executive Summary:

• The Bank Board voted unanimously to keep interest rates unchanged.
• The CNB ended its FX intervention regime and made forward guidance more symmetric.
• Governor Michl reiterated that the current dovish market bets may not materialise.

MNI CNB Review - August 2023.pdf

The Czech National Bank decided to keep its two-week repurchase rate unchanged at 7.00% after a 7-0 vote but signs of a gradual, cautious dovish pivot abounded. The Bank Board formally ended its FX intervention regime launched in May 2022 and announced the resumption of sales of the proceeds from international reserves, catching many market participants off guard. It also dropped hawkish bias from its forward guidance, switching to data-dependence, while Governor Ales Michl suggested that a discussion on interest-rate cuts could begin this autumn. However, the Bank Board also reaffirmed its intention to keep interest rates higher for longer and warned that the risks to the inflation outlook are skewed to the upside.

The koruna sold off sharply as the CNB announced the termination of its FX intervention regime. The central bank has not been active in FX markets since October, so in a sense the decision merely formalised the status quo. The decision does not mean that the CNB will not return to the market – the central bank pledged to “always as a matter of principle prevent excessive fluctuations of the koruna exchange rate that would jeopardise price stability or financial stability,” whenever the Bank Board deems it appropriate. Technically, stepping into the market remains an option for the Czech National Bank. On the other hand, terminating the FX intervention regime could be interpreted as a dovish move, at least in two respects. Firstly, it has a signalling effect – it suggests to the market that the Bank Board is now in the position to dismantle one of the pillars of its hawkish monetary policy. Secondly, the removal of a backstop against koruna depreciation caused its immediate depreciation by over 1% versus the euro and leaves it exposed to further pressures going forward, thus leading to an effective relaxation of monetary conditions.

In addition, the Bank Board tweaked its forward guidance in a way anticipated by Deputy Governor Jan Frait in the lead-up to the meeting. The Board removed the phrase “will decide at its next meeting whether rates will remain unchanged or increase” from the statement and said that “at its meetings ahead, [it] will base its decisions mainly on an assessment of newly available data and of the fulfilment of the forecast.” Speaking after the decision, Frait clarified that this change in wording does not eliminate the option of raising interest rates if upside risks to the inflation outlook materialise. What it does, is it makes forward guidance more symmetric and shows that it is “very likely” that the next move in rates will be a cut. On top of that, Governor Ales Michl suggested that the Bank Board could discuss rate cuts “in autumn at the earliest,” the first mention of a possible timing for such discussions.

In our view, the CNB’s monetary policy decision leaves the koruna exposed for further weakness, especially if the global risk backdrop deteriorates. It also opens the door to a continued pivot towards the easing cycle – albeit the Czech National Bank will likely proceed in a cautious and gradual manner. We are sceptical towards the current market pricing, with the Bank Board repeatedly emphasising its readiness to ignore staff recommendations and keep interest rates higher for longer to ensure that headline and core inflation ease sustainably to the +2% Y/Y target while inflation expectations are firmly anchored. Although the dovish tone of this week’s monetary policy decision takes us closer to the start of the first CNB rate cut, it is not a done deal that it will be delivered by the year-end.