Since we highlighted the potential of CE3 markets in July 2017 in light of the global reflation trend, our preferred trade – short EURCZK – has made a modest 2.8%. Even after this relatively anaemic rally, we believe that the koruna will now take a breather.

As a highly trade-dependent economy (imports + exports are 150% of GDP) and heavily integrated with the German industrial machine (which absorbs a third of Czech exports), the Czech economy has been buoyed by the global economic rebound. Similarly, inflation surged to a peak of 2.8% YoY in October on the back of the recovery in demand and the decaying of a supply-side deflation shock (top-right chart).

However, mirroring developments in the eurozone, the economy is now slowing and inflation has dropped sharply to 1.6% YoY in February. Given that the CNB and ECB tend to move in tandem (bottom-left chart), the dwindling prospect of any near-term monetary policy tightening in the eurozone suggests that the trajectory for Czech rates will similarly weaken. As such, we believe that there is now limited prospects for further CZK gains in the near term.

(Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception