June 11, 2018 / 12:17 PM / 13 days ago

Markets bet on early Czech rate hike as crown flounders

* Weak crown, strong wage data build rate hike case

* Central bankers acknowledging earlier hike possible

* Markets are expecting a hike by September

By Jason Hovet

PRAGUE, June 11 (Reuters) - Expectations of a Czech interest rate hike as soon as August to keep inflation at bay are growing, analysts and markets say, after the central bank indicated a weak crown currency and fast-growing wages made an earlier move possible.

The crown has been battered by a U.S. dollar rally and rising Treasury yields that led investors to sell emerging market assets. At the same time, concerns over the situation in Italy have also spilled over into central Europe in recent weeks.

Its weakness is making it harder for one of Europe’s most hawkish central banks to hold off on rate moves for now, while the European Central Bank still has an ultra-loose policy in place.

The Czechs have been counting on exchange rate gains to deliver the bulk of monetary tightening in 2018, with the bank’s staff forecasts pointing to a rate hike at the turn of the year.

But this tightening through the currency has not happened, even with strong wage, jobs and inflation readings in the past week.

“We have not had any tightening via the exchange rate at all since the start of February,” said Radomir Jac, chief economist at General Investments CEE, who sees a hike in August.

“Simply, a weaker crown means you should have more interest rate hikes.”

The crown, instead of heading towards 25 to the euro like the central bank’s forecasts assumed, has been stuck above 25.60 and even neared 26 amid market panic over Italy’s government in recent weeks.

The difference in where the crown is and where central bankers would like it to be is equal to roughly two rate moves - and markets are now betting via forward rate agreements that a hike will come by September.

Central bank Governor Jiri Rusnok last Tuesday gave markets his biggest signal yet that rates may soon rise, acknowledging the crown weakness is creating room for a rate increase.

A move up would put Czech rates further above ECB levels.

But the Czechs - even after three hikes between last August and February that brought the main two-week repo rate to 0.75 percent - still lag others in central Europe like Poland and Hungary. Hungary’s base rate is at 0.9 percent, while Poland’s is at 1.50 percent.

Only Romania has kept pace with the Czechs, raising its benchmark rate in three steps to 2.50 percent this year.

HAWKS AT PLAY

The Czechs were the first last year to begin normalising policy, lifting rates from zero, and are contending with a fast-growing economy that is seen expanding almost 4 percent in 2018.

Real wages are growing at the fastest rate in 15 years, unemployment is the lowest in the European Union, and real estate prices are among the fastest-rising in the bloc. Data on Monday showed inflation picked up faster than expected, to 2.2 percent and above the central bank’s target.

But the crown is 2 percent weaker since the last hike in February. In a Reuters poll on Thursday, analysts forecast the crown firming only slightly, to 25.550 to the euro, in the next month and reaching 25.450 in three months’ time.

That is well short of the central bank’s staff forecasts. Its outlook sees the crown at an average 24.80 in the third quarter and 24.60 in the fourth.

ING is among those saying the bank may move as early as its next meeting, which is on June 27. It is recommending investors pay front-end crown forward rate agreements to profit.

Citigroup economist Jaromir Sindel said the only thing that would keep the central bank from moving on rates in the third quarter was a sudden firming of the crown, for example to 25.20-30 per euro in June or July, which looked unlikely.

He expects a September hike although August was also in play. “We don’t expect some quick break (from the crown) during the summer... so I would say the central bank will be biased to a hawkish stance,” he said.

Additional reporting by Sandor Peto Editing by Hugh Lawson

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