Crowning glory: Czech tightening drives FX outperformance in 2021

WARSAW, Dec 31 (Reuters) – The Czech crown finished 2021 as the strongest performer in central and eastern Europe, at the end of a year in which central bankers in Prague took aggressive steps to tighten monetary policy.

Central and eastern European economies have bounced back strongly from the effects of the COVID-19 pandemic, and local labour shortages and strong wage growth have combined with global factors such as supply-chain disruptions and rising energy costs to create some of the highest inflation on the continent.

The Czech National Bank has provided the strongest reaction to price growth, raising its key two-week repo rate (CZCBIR=ECI) by a cumulative 350 basis points to 3.75% in a tightening cycle that started in June.

Economists say this has helped the crown outperform regional peers, strengthening about 5.3% against the euro over the course of 2021.

“The outperformance of the Czech crown has been driven by the decisive action… taken by the Czech central bank and its clear message that there are still some more interest rate hikes in the pipeline for early 2022,” said Radomir Jac, Chief Economist at Generali Investments CEE in Prague.

By contrast, the Hungarian forint weakened around 1.5% against the euro in 2021, while the Polish zloty shed about 0.8%.

“The Czech central bank has been pursuing a very aggressive monetary policy tightening cycle,” said Piotr Bartkiewicz, an economist at Pekao in Warsaw. “The other two central banks in the region (Hungary and Poland) were either delivering inadequate tightening or were hesitating, like the National Bank of Poland.”

The Polish central bank raised rates much later than its counterparts in the Czech Republic and Hungary, delivering its first hike in October.

Meanwhile, the National Bank of Hungary used more gradual adjustments of its interest rate corridor, at times delivering hikes that were smaller than what markets had expected.

Another factor that weighed on the zloty and the forint in 2021 was the disputes between the European Union and governments in Warsaw and Budapest over issues including the rule of law, a row that has held up the disbursement of COVID-19 recovery funds.

“Looking ahead to next year, as hiking cycles fizzle out, I expect external flows to come back into focus,” said Malin Rosengren, a portfolio manager at BlueBay Asset Management. “Here I think PLN and HUF will be challenged as the EU funding block becomes more material.”

Reporting by Alan Charlish in Warsaw; Editing by Alex Richardson

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