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ČNB interest cut forms a divide

Analysts are worried by sudden currency drop, others approve

By Claire Compton
Staff Writer, The Prague Post
August 20th, 2008 issue

Nearly two weeks after the Czech National Bank (ČNB) unexpectedly cut its benchmark interest rates by a quarter-point, the crown’s consequent drop has some ČNB board members concerned about the risk of an over-correction to the currency.
Despite ČNB Governor Zdeněk Tůma’s repeated announcements that the bank would cut rates this summer, most analysts expected the ČNB to stop at verbal intervention, since its primary responsibility is to hit inflation targets rather than manage exchange rates.
Nine days after the rate cut, Aug. 18, the crown closed at 24.24 Kč to the euro and 16.49 Kč to the U.S. dollar.
For ČNB officials concerned about the rocketing crown’s impact on the economy, the drop was a welcome development since the currency hit record highs in late July, hovering below the 23 Kč to the euro mark and around 14.50 Kč to the dollar.
Poland and Hungary have enjoyed similar currency gains over the past year, but have recently weakened due to the firming dollar. Unlike the ČNB, however, the central banks of those countries are considering hiking, rather than lowering rates.
Despite some ČNB board members’ concerns about a possible over-correction, at least one of them is considering the possibility of further rate cuts before the end of the year. Bank board member Pavel Řežábek told the daily E15 Aug. 18 that more cuts could be made in response to slowing neighboring economies and rising global prices.
Further cuts would seem counterintuitive to the ČNB’s stated priority of meeting inflation targets, but Řežábek said cuts would minimize the risk of falling below these figures.
“We will certainly hold a discussion about the lowering of interest rates,” he said. “The reason is simple: We must take care so that the restriction that will hit the whole world due to the slowdown of economies does not lead to our undershooting of the inflation target.”
Raiffeisenbank analyst Aleš Michl said the idea of an over-correction is laughable given the growth in the past year, and suggested there was room for more regulation. The ČNB’s actions are only one factor in the movement of the exchange rate, he added.
“Ninety percent of the movement can be explained by the U.S. dollar on the world market, and10 percent of the movement can be explained by the reaction of the Czech National Bank,” he said.
Ultimately, analysts were surprised by the ČNB’s interest rate cuts because they could potentially undermine inflation targets.
“Right now, inflation is at 6 percent or 7 percent,” Michl said. “[The ČNB] wants to have it at 2 percent, so it’s not very logical to cut interest rates [again].”

Claire Compton can be reached at ccompton@praguepost.com


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