By Michael Winfrey
PRAGUE, July 24 (Reuters) - The Czech central bank has hauled
the meteoric crown partially back to earth by saying it may cut
interest rates next month, but the currency's reaction to the
statement and persistent price pressure may forestall just such
a move.
The crown <EURCZK=>, the world's best performing currency
against the euro and dollar this year, has been boosted by a
surge in investor sentiment on central and Eastern Europe.
But a slide to its lowest point in three weeks -- prompted
by the verbal intervention of bank Governor Zdenek Tuma as well
as the dollar's rise and generally lower risk aversion -- shaved
as much as 3.9 percent off the currency compared to a record
high hit on Monday.
Analysts said the bank would probably hold rates at 3.75
percent -- the lowest in the European Union -- at a meeting on
Aug. 7, following a series of hikes that ended in February.
That is a shift from less than a month ago when the market
had priced in an at least 25 basis point hike in the coming
months, but the swing did not go as far as to expect a cut.
"Given still very high inflation, we do not expect the
(central bank) to opt for policy easing, especially since
yesterday's verbal intervention has apparently worked, lifting
euro/crown to levels more aligned with real economy
fundamentals," said Michal Dybula, an analyst at BNP Paribas.
"These fundamentals remain supportive for a strong crown,
though not as strong as seen over the past several days."
INFLATION TARGET
Before Tuesday, the crown had gained 13 percent to the euro
this year in local currency terms, and its climb -- also seen in
regional peers the Polish zloty <EURPLN=> and the Hungarian
forint <EURHUF=> -- accelerated after the European Central Bank
indicated its July rate hike would be the last for a while.
The crown is also a linchpin of Czech monetary policy. Its
sharp rise helps quash import prices but it has also squeezed
exporters, leading to fears of a sharp slowdown in growth and a
drop in demand and inflation.
Tuma told Bloomberg the crown had taken so much steam out of
price growth the bank would stop discussing hikes and focusing
on whether to hold or cut rates at the Aug. 7 meeting.
He also said it could cause inflation to undershoot the
bank's target of 3 percent plus or minus one percentage point
next year, versus its forecast of 7 percent or more this autumn.
Analysts were sceptical, saying the risk of oil- and
food-fuelled price growth still persisted, as well as domestic
pressure and waged demands, making any rate cut unlikely.
"The inflation risk is still there and it's still too soon.
They're just trying to talk down the currency basically," said
Capital Economics economist Neil Shearing.
"It's pretty complacent to say 'we're at risk of
undershooting our 3 pct plus or minus 1 pct target'... I'm not
aware of any country that has cut inflation from over 7 percent
to under 2 in the space of 18 months, which is what the Czechs
would have to do. It's possible, but it's fairly unlikely."
CURRENCIES DRIVE POLICY
Hungary's central bank left interest rates unchanged at 8.5
percent on Monday. It cited the strong forint, although it said
it would hike again if needed to meet its 3 percent inflation
target, well below the June rate of 6.7 percent.
In Poland, where many analysts expect at least one more
interest rate hike from 6.0 percent now in around October,
officials have tried to talk down the zloty, which has jumped
9.3 percent against the euro this year.
In all three cases, currency strength is becoming a
determining factor in how central banks view rates.
The Czech central bank sees the crown's equilibrium real
appreciation rate at 5.5 percent this year and 4 percent next,
much slower than the current rate. Despite Tuesday's and
Wednesday's slide, the crown is up a nominal 10.82 percent to
the euro and 17.35 to the dollar this year.
The bank, which focuses policy on a 12-18 month horizon,
said in May it expected inflation to slow to 2.2 percent in the
third quarter of 2009, with interest rates falling in late 2008.
But it made the forecast when the crown traded at 25.18 to
the euro, and was expected to continue appreciating much more
slowly than it has since the estimate.
JP Morgan EMEA Economist Miroslav Plojhar said inflation was
still too high for an August rate cut by the Czechs, and price
pressures remained down the road. But the crown would be key.
"If the crown stays strong, even with dovish talk from the
Czech central bank, the bank will have to act and the first rate
cut is to come already in September," he said.
(Editing by David Christian-Edwards)
