Crown hits high against USD, euro

The Czech crown was awarded a dubious distinction for the month of July when Bloomberg reported the currency had the biggest growth out of the 170 currencies it tracks, gaining 3.7 percent against the euro.

Growth doesn't always mean good, however, especially in an export-dependent economy where a strong currency means fewer buyers for exporters.

"The recovery in industry is fragile, and a too-strong Czech crown will be unwelcome," said Jiří Škop, a researcher at Komerční banka (KB). "It may hurt Czech economic growth with higher unemployment, for one, which is not too good in times of fiscal consolidation."

The crown recently hit a 21-month high July 29, its strongest since November 2008, before softening slightly in advance of the Czech National Bank's (ČNB) board meeting, where analysts expected policymakers to at least make a verbal intervention.

"Their comments regarding the crown were neutral," Škop said. "We thought there should have been mention of a too-strong crown, but they didn't do that."

ČNB Governor Miroslav Singer did address the recent trajectory at a press conference afterward, comparing it to a speeding train, albeit one he expected to slow down.

"The train is not so far from where we expect it to be, but it is going really fast. ... In the past two weeks, there has been a relatively dramatic shift," he said. "If the train stops where it is right now, there will not be any drama. But the speed leads one to speculate about where it could go. If it continues at its current pace, then we would be at a point where inflation would be threatened, and we'd be forced to react."

Dramatic growth aside, the crown's exchange rate is nevertheless within the bank's estimates, and the conservative Singer said he "didn't want to scare anyone."

"Of course I didn't want to create a situation in which a trader in some bank is chasing his analysts for getting the forecast [of the central bank decision] wrong," Singer said.

The steep growth isn't expected to continue, according to ČNB forecasts, which adjusted its estimate for the crown at the July 29 board meeting. The bank's latest forecast expects the average exchange rate of the crown to be 25.40 Kč/euro. Next year, the bank expects the crown to trade at an average rate of 24.30 Kč/euro. It had previously forecast 2011's rate to be 24.90 Kč/euro.

The bank left the two-week repo rate unchanged at a historic low of 0.75 percent.

So far, the crown hasn't hit the dizzying highs of the summer months of 2008, when the currency traded below 23 Kč and 15 Kč to the euro and U.S. dollar, respectively.

Still, currency growth of more than 5 percent in a year can have negative effects on price developments and throw off ČNB's inflation targets.

"If the crown strengthens faster than 5 percent per year for more than a year, the competitiveness of the economy would be strongly hit," said Markéta Šichtařová, director at Next Finance. "Moreover, there would be significant deflationary pressures. In that case, I could see the central bank try to smooth the crown's trajectory."

The currency's recent breakaway tear stems from a combination of political and geographical factors. Investors see the crown as a better bet than other regional currencies, and the recent election and subsequent economic measures have further bolstered positive sentiment, Škop said. On top of that, recent economic indicators such as industrial output and trade balance have come out positive for the Czech Republic.

There are two major factors and several smaller factors, added Šichtařová.

"The major factor is a huge surplus of Czech foreign trade together with the fact that the crown may appear to be the most reliable among CEE currencies," she said. "Other countries, such as Hungary, have problems with their public finances or are experiencing a bigger economic slowdown. But the Czech Republic has quite strong fundamentals together with a government that claims to be willing to stabilize public finances."

Recent data released from the Czech Statistical Office continues to be largely positive, which could continue to influence the strengthening crown. Industrial output in June was up 9.7 percent year on year, according to the office. Sales from direct exports were also up significantly, with a 17.3 percent year-on-year growth in June.

"Together with export activity statistics, these figures confirm that the situation in Czech industry is really improving," said an Aug. 6 report from KB.

Claire Compton can be reached at
ccompton@praguepost.com