Today I wish to take a journey to central Europe to take a look at a place which was described by British Prime Minister Neville Chamberlain in September 1938 like this.
“How horrible, fantastic, incredible it is that we should be digging trenches and trying on gas-masks here because of a quarrel in a far-away country between people of whom we know nothing.”
Of course there are some geo-political issues of that time which are recurring but as we note that the country of back then was spilt into two as we now have Slovakia and the Czech Republic there is something else to interest us. This is the exchange-rate policy of the Czech National Bank (CNB).
The CNB therefore decided in November 2013, in accordance with its statutory mandate to maintain price stability and in line with its previous communications, to start using the exchange rate of the koruna as an additional monetary policy instrument.
A slightly curious description as in preceding paragraphs they told us that what we would now call Forward Guidance on the subject had been working.
caused the Czech koruna to weaken in late 2012/early 2013
We are of course familiar with central bankers struggling with reality and Forward Guidance being a particular problem on this front with up regularly being the new down. However in spite of the claimed improvement we find ourselves noting that yet again what is described these days as “Moar” was required.
The CNB undertook to intervene in the foreign exchange market to weaken the koruna so as to maintain the exchange rate close to CZK 27 to the euro. This exchange rate commitment is asymmetric, i.e. the CNB will stop the koruna appreciating below CZK 27 to the euro but will leave any further depreciation above CZK 27 entirely in the hands of supply and demand on the foreign exchange market.
What is the significance of this?
The first is simply geography and I mean by this proximity to the Euro which has caused problems for a raft of countries around it most notably Denmark and Switzerland with their negative interest-rates. Also the Swiss National Bank has become an enormous hedge fund via its currency interventions and recycling policy. Right now with equity markets on highs that looks a cunning plan but of course trying to realise it on any scale could switch that to the sort of cunning plan espoused by Baldrick in the television series Blackadder.
Next comes the issue that the more you fix the exchange-rate the less you can do about internal monetary policy. As the Swiss have found above the money supply and other matters cannot now be controlled. There is a Swiss like element to the policy.
The CNB can use infinite amounts of koruna to purchase foreign currency, as it itself issues the Czech currency in both paper and electronic form. The CNB is resolved to intervene in such volumes and for such duration as needed to maintain the chosen exchange rate level.
Be careful what you promise! Anyway the Koruna went above the 27 level until late summer 2015 since when if you are willing to ignore minor moves a fixed exchange-rate at 27. The price of this is that it needed to intervene starting at just over 1 billion Euros worth in July 2015 and peaking at just under 4 billion last October. The small-scale is probably simply the fact that for many of the main currency players and investors it is too small a market to bother with and that is for those who know it exists! Sometimes small is indeed beautiful.
What happens next?
Well on the 22nd of December this was decided.
The Bank Board therefore states again that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017 Q2. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017.
I guess worries immediately arise about any Forward Guidance from a central bank as we note that exit strategies if we are being polite have proved to be somewhat problematic. This morning’s update from the Czech Statistical Office has brought this into focus.
Consumer prices in December increased compared with November by 0.3%…….. The year-on-year growth of consumer prices amounted to 2.0%, i.e. 0.5 percentage points up on November. It is the highest year-on-year price growth since December 2012.
This is a bit like the point where a train or aircraft announces that you have arrived at your destination! What caused this?
The month-on-month rise in consumer prices in ‘food and non-alcoholic beverages’ came primarily from the increase in prices of vegetables by 10.6%, of which prices of vegetables cultivated for their fruit rose by 40.8%.
Are “vegetables cultivated for their fruit” tomatoes? Anyway the Czechs are seeing an outbreak of food inflation which of course hits the poorest the most.
Prices of rolls and baguettes were higher by 10.4% (1.5% in November), eggs by 13.7% (10.3% in November), fresh butter by 20.7% (16.6% in November). Prices of vegetables cultivated for their fruit were higher by 41.5% (a drop by 10.1% in November).
It looks like there are effects here which may unwind a bit but as we go into 2017 we can expect more of this if we look at the price of crude oil.
In ‘transport’, prices of automotive fuel turned from a drop in November by 0.3% to a growth by 4.3%.
Actually if we were to use the Euro area standard which has some logic if you are shadowing it as a currency then we are above the inflation target already albeit marginally.
the HICP in the Czech Republic in December went up by 0.3%, month-on-month, and by 2.1%, year-on-year.
Oh and there is a be afraid, be very afraid moment in the further detail.
So far, imputed rentals have been excluded from the HICP
If this from fastFT is any guide then the word control needs to go into my financial lexicon for these times.
Policymakers have maintained a hard upper limit on the koruna at CZK27 against the euro since 2013 in a bid to control inflation
What about unemployment?
Whilst the CNB has trouble ahead there is one area where things look pretty good and I mentioned it in passing yesterday as we looked at Germany.
the lowest unemployment rates in November 2016 were recorded in the Czech Republic (3.7%) and Germany (4.1%).
If we look more generally economic growth had disappointed a bit according to the CNB.
Industrial production growth slowed considerably, mainly reflecting an unexpected downturn in exports in October. The long-running decline in construction output, caused mainly by a drop in public investment, slowed only marginally in October. Retail sales growth remains at solid levels.
Since then we have discovered that industrial production rose by 1.3% in November on the month before making the numbers in that area look better.
More German than the Germans
If I give you a couple of snapshots you will understand what I mean.
The general government balance expressed as a percentage of GDP reached a high surplus of 2.16 percent in the third quarter of 2016…….General government consolidated gross debt decreased annually by 1.92 p.p. to 38.73 percent of GDP.
No doubt there is a (long) word in German for this but that is way beyond my language skills. Also whilst we are in a Germanic style surplus zone there is this.
In January−November 2016, trade surplus in ‘national concept‘ reached CZK 189.9 bn which represented a y−o−y increase of CZK 57.8 bn.
So far I have avoided the phrase competitive devaluation but this is what we have seen from the Czech Republic. To put it another way it can be labelled as “exporting deflation” as it has kept its exchange rate lower than otherwise to gain a competitive gain which means that someone else has lost via a competitive disadvantage. Not too friendly and this has been added to via the fact it has shadowed the Euro which itself has fallen. If we were looking for a concrete example of this then perhaps Reuters have shown us one earlier today.
Skoda Auto, the Czech unit of carmaker Volkswagen (DE:VOWG_p), raised global deliveries by 6.8 percent to a record 1.13 million cars in 2016, lifted by rising sales in Europe and China, the company said on Tuesday.
This leaves us with two issues. The first is that the economies trying to lower their currency are a large group if we start with the main group of the Euro area, China and Japan with the UK of course also recently depreciating. Secondly looking forwards the CNB faces the issue of how it exits if inflation picks up quickly or whether it follows the central banker philosophy of shouting both “temporary” and “counterfactual” whilst looking the other way.