The Czech koruna has had a year in which it weakened very significantly against the US dollar and the euro. Although it has improved a bit in recent days, if we take the difference from last year into account, the weakening against the euro is really big. A year ago, the koruna was at 23.50 per euro, while today it reached 25.25 per euro. What is behind our weak currency and what does it mean for Czechs as consumers?
On Tuesday, the koruna traded at 25.26 against the euro, and the exchange rate against the dollar was 23.67 koruna. At this time last year, the exchange rate was just over 21 crowns to the dollar. Further developments in the exchange rate of the koruna may again affect the May meeting of the bank board, which could decide on a further reduction in interest rates. Most recently, the CNB lowered the base interest rate by half a percentage point to 5.75 percent.
The action of our central bank, which has already lowered interest rates for the second time, is one of the reasons why the koruna is weak. When interest rates are higher, it attracts foreign investors to buy Czech government bonds. With falling rates, such an investment is no longer so profitable. On the contrary, the European Central Bank (ECB) and especially the US Fed are much more cautious with the easing of monetary policy. In addition, the fact that the performance of our economy continues to be weak is very much related to this, which, on the other hand, cannot be said about the US economy.
“Regarding the US dollar, the Czech koruna has weakened by about 11% over the past year, mainly due to the growing interest rate differential, which portends different developments in the economy. The United States economy is holding firm despite high interest rates mainly thanks to numerous fiscal stimulus and various liquidity programs. The GDP of the United States thus grew year-on-year in the third quarter of 2023 at a rate of 4.9% and in the last quarter at a rate of 3.4%. In the same periods, the Czech economy declined by 0.8%, or grew by 0.4%. Not only was fiscal policy less stimulating in Europe than in the US, the Czech Republic is also the most industrialized country in the EU, and its economy is therefore the most sensitive to increased interest rates,” BHS analyst Timur Barotov told the editors.
This means that our economic recovery is the slowest of almost all European countries. At the same time, however, it should also be true that when interest rates reach an even lower level, there will be a delayed rebound in the domestic economy, and this will hopefully close the gaping gap.
As for the US, the market is already preparing for a scenario where the Fed may not cut interest rates even once this year. On the contrary, the CNB will very likely continue with easing. “It no longer makes sense for large and speculative market players to keep their funds in Czech banks and Czech government bonds. Their attractiveness compared to American ones is significantly decreasing and there is a shift of capital in favor of the dollar. Further developments will significantly depend on US government bond yields and inflation expectations. Currently, US inflation expectations are rising and driving yields higher. This development may continue because the American Fed is losing confidence and the market stops believing that inflation will be tamed there to the two percent limit this year,” Barotov claims.
Oil, which is 20 percent more expensive, also plays a role
The koruna weakened against the euro for similar reasons as the dollar. Economic recovery in European countries is faster than in the Czech Republic, and the ECB is not reducing rates either. After all, the koruna weakened less against the euro in the last month than against the dollar, and even strengthened in recent days.
“Inflation in the Eurozone is less of a problem than in the US due to weaker economic growth, so the ECB is not expected to have to be as tight as the US Fed.” This makes it much more likely that ECB interest rates will start to fall earlier than in the US. Thus, the interest rate differential may begin to increase in the second half of the year in favor of the Czech crown. The official forecast of the CNB is also thinking in this direction. It can therefore be assumed to a certain extent that this development will be maintained in the coming months and the koruna will strengthen slightly against the euro,” said Barotov.
However, what can still affect the situation is the potential “spillover” of American inflation into Europe, as well as the fact that the price of oil has risen by twenty percent since the beginning of the year, which is a strongly pro-inflationary factor.
A weak koruna against the EU currency will make vacations abroad more expensive, which also applies to a stay in the United States. The same can be said about buying plane tickets. Precisely due to the aforementioned increase in the price of oil, which is mainly traded in dollars, fuel prices at domestic gas stations will also increase significantly due to the weak koruna.
