The currency peg problems of the Czech National Bank mount

A regular issue in economic  discussions is of course exchange-rates and their impact. There are strengths and weaknesses in both floating and fixed exchange-rates and today I am going to look at a variant of a fixed exchange-rate. The irony here is that it is caused by another fixed exchange-rate as we see yet another country struggling to cope with the consequences of being a near neighbour to the supermassive black hole that is the Euro project. We have at various times looked at Denmark, Sweden and Switzerland but today it is time to return to the Czech Republic. This feeds into another of my themes which is how do the central planners return to free markets? One issue that has arisen overnight is the one of some “being more equal than others” at such times. From Reuters.

Richmond Federal Reserve President Jeffrey Lacker abruptly left the U.S. central bank on Tuesday after admitting that a conversation he had with a Wall Street analyst in 2012 may have disclosed confidential information about Fed policy options.

The 2012 leak had triggered a criminal investigation after research firm Medley Global Advisors told its clients the details of a key Fed meeting a day before the Fed released its own record of the discussion.

At the Fed’s September 2012 policy meeting, officials laid the groundwork for the massive bond-buying stimulus they were to roll out later that year. Early knowledge of that discussion could have given some traders an unfair edge.

I do like the word “may” because if he did not do it why is he resigning? Also how has this dragged on to as it happens only 6 months before his retirement. Due to the scale of potential gains and losses here there should be a full investigation and maybe a criminal one. Ironically this is one of the few cases of central bank Forward Guidance being accurate which we can file with the foreign exchange dealings of the wife of a past head of the Swiss National Bank and the way the ECB used to privately brief its favourite hedge funds.

The Czech National Bank

Back in 2013 it did this.

The CNB Bank Board decided to use the exchange rate as a monetary policy instrument, and therefore to commence foreign exchange interventions, on 7 November 2013……This means the CNB will not allow the koruna to appreciate to levels it would no longer be possible to interpret as “close to CZK 27/EUR”. The CNB prevents such appreciation by means of automatic and potentially unlimited interventions, i.e. by selling koruna and buying foreign currency.

So a familiar move in that we see another central bank wanting a lower level for its currency. As ever the inflation target is used as cover for what is really yet another version of a competitive devaluation.

A weakening of the exchange rate of the koruna leads to an increase in import prices and thus also in the domestic price level.

Another familiar theme is the promise along the lines of “whatever it takes” or the infinite intervention promise made by the Swiss National Bank.

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.

The Czech economy

The labour market is one where the Czech economy has done extremely well according to the latest data. From Czech Statistics.

The general unemployment rate of the aged 15 – 64 years , seasonally adjusted, reached 3.5% in February 2017 and decreased by 0.8 p.p., year-on-year……..The employment rate , seasonally adjusted, reached 73.4% in February 2017 and increased by 1.9 percentage point (p.p.) compared to that in February 2016.

Even rarer was the strong growth in wages seen in 2016.

The continuous demand for labour force exerted pressure on the growth in earnings so the overall average wage increased nominally by 4.2%. The median wage, i.e. the wage of a middle employee determined from a mathematical-statistical model of the wage distribution, increased even more markedly by 6.0%.

They are by far the best labour market figures I have looked at for quite some time so let us continue with the good economic news.

In January 2017, working days adjusted industrial production increased at constant prices by 4.3%, year-on-year (y-o-y). Non-adjusted industrial production was by 9.6% higher. Seasonally adjusted industrial production increased by 3.5%, month-on-month (m-o-m). The value of new orders increased by 7.0%, y-o-y.

The main driver of this was the automobile sector.

manufacture of motor vehicles, trailers and semi-trailers (contribution +3.8 p.p., growth by 18.7%),

With the strong wages and employment data you will not be surprised to see that this morning’s retail sales data was positive as well.

In February 2017, seasonally adjusted sales in retail trade at constant prices increased by 0.9%, month-on-month (m-o-m). Sales adjusted for calendar effects increased by 4.8%, year-on-year (y-o-y).

Actually with all the good news above the total number for economic activity disappoints but is still solid.

According to a refined estimate, the gross domestic product in the fourth quarter of 2016 increased by 0.4%, quarter-on-quarter (q-o-q), and by 1.9%, year-on-year (y-o-y). The GDP growth for the entire year 2016 was 2.3%.

Looking ahead the manufacturing business surveys look strong so far in 2017.


Back on the 10 th of January I highlighted this issue.

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.

Well it isn’t the highest for that period anymore.

Consumer prices in February increased compared with January by 0.4%. This development was primarily due to a rise in prices in ‘food and non-alcoholic beverages’, ‘recreation and culture’. The year-on-year growth of consumer prices amounted to 2.5%, i.e. 0.3 percentage points up on January.

It was a grim month for healthy eaters in particular.

the increase in prices of vegetables by 15.2%, of which prices of potatoes rose by 24.1% and prices of vegetables cultivated for their fruit increased by 28.1%.

We are likely to see a fall in the annual rate in March if the experience elsewhere is repeated but none the less the objective has been reached.


The Czech economy is in good shape in many respects and quite a few countries would switch circumstances. Economic growth with a very healthy looking labour market although past central bankers might be wondering about responding especially with an interest-rate called “technical zero”. Added to this one could use the phrase “mission accomplished” on the inflation front so how do they respond?

sustainable fulfilment of the 2% inflation target in the future. Sustainable fulfilment of the target following the return to the conventional monetary policy regime is crucial for the timing of the exit from the exchange rate commitment.

The central planners fear an uncertain future and have got cold feet. The catch is that they are applying a very strong economic stimulus to an economy which is doing well so the policy is inappropriate also the countries the Czech Republic trades with will have good reason to wonder how much of the economic activity is being poached from them?

What is the exit strategy and will we see a Swiss National Bank style debacle?

House Prices

A familiar tale comes from the Global Property Guide.

Wow!  The average price of apartments in the Czech Republic surged by 11.87% (11.24% inflation-adjusted) during the year to Q3 2016, the country´s eleventh consecutive quarter of strong price hikes, according to the Czech Statistical Office (CZSO),

The currency problems of the Czech Republic mount

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.

Denmark’s economy waits for the next move of Mario Draghi and the ECB

One of the features of our time is that politicians like to put up other countries as models for their own. Sadly for the model country that often represents a peak and the only way then is down to misquote Yazz. Rather oddly Denmark has appeared in the race for the Democratic nomination in the United States as Bernie Saunders has been praising it as a socialist utopia and Hilary Clinton also praising it. The Danish Prime Minister took the time and trouble to rebut this in a speech at Harvard.

I know that some people in the US associate the Nordic model with some sort of socialism. Therefore I would like to make one thing clear. Denmark is far from a socialist planned economy. Denmark is a market economy.

Of course as leader of a centre-right coalition he was always likely to say that. Rather intriguingly he went on to say this.

Denmark is sometimes compared to a bumblebee—at first sight it seems almost impossible that a bumblebee would be able to fly, but it does,

Some good news for Denmark

The Legatum Prosperity Index told us this earlier this week.

Denmark ranks 3rd globally in the 2015 Prosperity Index, having risen by one place since last year.
Denmark’s best performance is in the Entrepreneurship & Opportunity sub-index, where it ranks 2nd in 2015.
Denmark’s lowest rank is in the Health sub-index, where it ranks 16thin 2015.

Last week the World Bank was issuing praise as well. The Danish government reported it thus.

Denmark moves into the top 3 in the World Bank’s ‘Doing Business’ ranking published today.

Perhaps these organisations are fans of Fat Boy Slim.

I have to praise you
I have to praise you
I have to praise you
I have to praise you like I should

If we look into the detail of the Legatum Report then Denmark had in the previous 5 years  per capita GDP growth of -1.1%. Now 2013 is a bit out of date but poses a question and further research poses other questions.

While many other advanced economies have made progress on the Economy sub-index since 2009, the Nordics have been going backwards. Three of the five Nordic countries have slipped down the Economy sub-index rankings since 2009.

Looking at Denmark specifically whilst its unemployment rate has fallen it has done so more slowly than the UK and whereas pre credit crunch it had a lower unemployment rate it is now higher. Interestingly the Lego Group is doing well expanding and creating jobs. Can it help? Yes but it is mostly doing this according to its update.

The factory in Mexico is planned to undergo a massive expansion, adding up to 190,000m2 to the factory……The LEGO factory in Nyíregyháza, Hungary, is also planned to undergo significant expansions.

Mimicking the Japanese model?

The Bumblebee

Currency Peg

Denmark has a sort of semi-detached relationship with the Euro as it has a currency peg. So as I pointed out at the time the Danish Kroner will have been pulled downwards just over a week ago when the “Open Mouth Operations” of Mario Draghi talked the Euro lower. This is back on the agenda this morning as the Euro dips into the 1.09s versus the US Dollar taking the Kroner with it. So whether the like it or not the Danes have found themselves with a depreciating exchange rate courtesy of the ECB.

If we switch to strains in the exchange-rate with the Euro then the Nationalbanken had been able to reverse around 2/3rds of the intervention it had made around the turn of the year. Except we now see that the Kroner is dipping again in response to the recent Draghi promises. Is there a Lego version of what is being called Draghi’s christmas train?

The currency peg has become ingrained as a way of life in Denmark but if it did not exist would you start one now? I would suspect not although of course there are always going to be issues being so economically close to the troubled behemoth which is the Euro.

Negative Interest-Rates

One of the ways that Denmark stabilised its currency earlier this year was to cut interest-rates. It had several goes before agreeing with Switzerland that -0.75% was the way to do it. Accordingly Nationalbanken members may have got some of their breakfast bacon caught in their throat or spluttered into their coffee as they read Mario Draghi’s interview with Il Sole 24 Ore. if he does carry out the hints of further deposit-rate cuts then Denmark will find itself moving towards and maybe reaching -1%.

The Danish government bond market has also been affected and the two year yield is -0.08% so it is yet another country which is being paid to borrow which is presumably why it issued a 2018 bond earlier this month. In a way the fact that a bond with a 0.25% coupon replaced one that had a 2.5% one speaks volumes.

The housing market

If you slash interest-rates into the icy cold negative zone then you risk trouble and the latest review from the Nationalbanken suggests it is worried.

House prices are forecast to rise by 6 per cent
this year, and much of this increase has already
taken place

Indeed you may spot below the use of a word that has been redacted from most central banking dictionaries and lexicons.

price increases for owner-occupied homes remain high. The highest increases have occurred in the Copenhagen area and to a slightly lesser extent in other cities. Especially the rate of price increase for homes in certain parts of the Copenhagen area is unsustainable, and there is a risk of a local house price bubble.

The banks do seem able to lend for at least one purpose.

Total lending by banks and mortgage banks to
households and non-financial corporations grew
by kr. 17 billion from March to July.
The increase is mainly attributable to lending
by mortgage banks to households.

There has been something of a boom bust cycle already in the price of owner occupied flats as the 100 of 2006 fell to below 75 in 2009 and the trod water. However things picked up in 2012 around the time of the “whatever it takes” speech and now if I am reading the chart correctly we are around 104.

What happens next? Well we do get a hint.

This indicates that the low interest rates have not yet been fully factored into house prices.


If we continue with the animal imagery then the Danish economy has some of the features of a Swan because if we peruse the quote below after seeing all the international praise all looks calm.

GDP was 1.7 per cent higher in
the 1st half of 2015 than one year earlier.

Yet if we move to the currency and interest-rate situation we get a very different emphasis because a stable serene Swan does not need negative interest-rates. Is there a type of Swan event which covers this? Well if interest-rates get forced lower and house prices pushed higher then it will be time for the delightful Taylor Swift.

I knew you were trouble when you walked in
So shame on me now
Flew me to places I’d never been
Now I’m lying on the cold hard ground
Oh, oh, trouble, trouble, trouble
Oh, oh, trouble, trouble, trouble

Update midday

I note that the UK current account is hitting the newswires a bit today so here again is a link to my critique of the data series and methodology.