News

Staying on hold after the front-loaded cuts

We expect the CNB to stay on hold next Wednesday. The bank already delivered a cut larger than the CNB staff recommendation in May, particularly when the falling interest rate trajectory in 2H20 is considered. This means that rates might stay unchanged next week, and potentially even during the meetings ahead, as suggested by the latest CNB communication. We see CZK as a CEE outperformer and look for CZK IRS and CZGB curves steepening in line with higher core rates.

• The CNB will not publish new forecasts next Wednesday. It will only assess how the latest economic developments correspond to the May QIR forecast. No significant deviation from the May forecast is apparent so far, which would suggest that the Czech economy is not switching to the CNB’s adverse scenario and, as such, no more monetary easing is needed.

• Indeed, 1Q20 GDP of -3.3% QoQ (-2.0% YoY) was in line with the forecast, though the structure of growth differed, as the CNB expected a less intense fall in investments (-11.4% vs -5.4%) and a more severe fall in foreign trade (-2.4% vs -5.8%). CPI decelerated at a slower pace and ended above the CNB forecast in May (2.9% vs. 2.6%). Core inflation even accelerated from 2.7% to 3.3% in May due to a decline in taxes. These taxes are excluded from the CNB core inflation measure.

• Wage growth of 5% YoY in 1Q20 was above the CNB forecast of 4.2%. Market-segment wages in particular grew more than the central bank expected (5% vs 3.8%). CZK has recently appreciated below 26.7 EUR/CZK, stronger than the CNB forecast of 27.2 for 2Q on average. Average EUR/CZK in 2Q is at 27.1 up until now, so the deviation from the CNB forecast it negligible.

• The CNB reduced its countercyclical capital buffer further from 1% to 0.5% yesterday. As such, these measures should not be a part of next week’s meeting

• All in all, the CNB surprised during the last two meetings and delivered higher than expected cuts. But this time an on-hold decision seems the most likely. The latest CNB communications from V. Benda, M. Mora and Governor Rusnok all suggested that rates might stay on hold for some time, supporting no change next week.

FX: The expected on-hold CNB decision should have muted impact on CZK as the market is pricing in low probability of a cut and the latest CNB interest rate forecast also points to flat rates for the rest of the year. Among low yielding CEE FX, CZK remains our top pick. The relatively strong fiscal position, an inflation minded central bank and, in our view fairly low odds of FX interventions to lean against possible currency strength (CPI is slowing very gradually and deflation risks are not present now) all make the koruna attractive. We see EUR/CZK at 26.00 by the year end.

Domestic Bonds & Rates: We see the CNB being largely done with easing measures. Given the CNB’s strongest focus on inflation of the CEE central banks, the CNB should be the least dovish central bank in the region from now onwards and eventually be the first to start tightening. This suggests further 1s3s CZK curve steepening vs PLN. CZGBs remain the safe harbour in the CEE space. Despite the CNB being the only CEE central bank not engaging in QE and the MinFin frontloading the supply of bonds, CZGBs have done well due to their high credit quality and constructive FX outlook. CZGB yields at the belly and long-end should trade in line with the expected gradual rise in core yields.