Europe's first rate hike may be coming this week

Europe's first rate hike may be coming this week
Published: 31 July 2017
The Czech Republic may kick off Europe's monetary-tightening cycle this week, jumping ahead of its peers after three years of radical stimulus fueled price growth that's sputtered on the rest of the continent.

Economists are almost evenly split, with 11 of the 21 surveyed by Bloomberg last week saying the Czech National Bank would raise its benchmark to 0,25 percent at its Aug. 3 meeting from a record-low 0,05 percent.

The rest predicted no change. If there's a hike, it will be the first in more than nine years, and it would boost the appeal of koruna assets as other rate setters stay put and the European Central Bank holds off on announcing curbs to its quantitative-easing program until fall.

While policy makers from the euro area to Hungary are waiting for more evidence that their economies have recovered enough to raise borrowing costs, the Czechs are spoiling for action.

What sets them apart is an unconventional regime of near zero rates and interventions that clamped a lid on koruna gains from 2013 to April of this year. And while inflation is still moribund across the continent, policy makers in Prague are tackling price growth that's risen above their 2 percent goal, spurred by a spike in wages and the lowest unemployment rate in the 28-member European Union.

"Czech inflation has been above the target, and a tight labor market suggests the economy is operating above its potential, a standard signal for tighter policy," said Radomir Jac, chief economist at Generali Investments CEE in Prague, who sees a hike next week.

"I expect the CNB to raise interest rates cautiously, in small steps and with longer pauses in between, at least until monetary tightening also becomes a reality in the euro area."

The currency cap helped fend off deflation and boosted the competitiveness of exporters including Volkswagen AG's Skoda Auto AS and brewer Pilsner Urquell AS.

While Czech rate setters in Prague have repeatedly noted that koruna gains and the euro-area stimulus are limiting their scope for tightening, they said on June 29 they were likely to make a move this quarter.

'Policy Divergence'

Bets on rising interest rates have boosted the appeal of the koruna, which has surged 3,8 percent to the euro since the April 6 end of the intervention regime, the most among 31 major currencies tracked by Bloomberg. The central bank previously said 1 percent of exchange-rate appreciation delivers about the equivalent of a quarter-point rate increase.

Another reason to tighten is the central bank's wish to smother a potential mortgage bubble after Czech home prices grew at the fastest pace in the EU for two quarters. Policy makers have repeatedly said they prefer to cool the housing market through tighter capital requirements and lending standards, but their concern might tip the scale for a rate hike.

Still, some analysts are predicting no change. Jose Cerveira at JPMorgan Chase & Co. in London says the new inflation forecast that central bankers will debate is unlikely to differ significantly from the one they've relied on for the past three months.

He said the board will want to wait for more clarity about the ECB's tapering plans. And even those who project the first rate increase on Aug. 3 see the timing as far from certain.

"The CNB may also want to delay the move so that the period of policy divergence versus the ECB is shortened," Bank of America Corp. economist Mai Doan wrote in a report. "But we think that it is just a matter of months for the hikes to come, so why the wait?"

- Bloomberg
Tags: Interestrate,

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