Czech inflation surge piles more pressure on currency limit. Blame potatoes.

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That creaking noise you can hear comes from the weight building up on a certain floor in Prague.

Earlier this week, a huge surge in foreign-currency reserves showed that the Czech National Bank is clearly fighting an intense battle to keep its exchange-rate limit in place. Today, fresh inflation figures help explain why this is happening.

The annual pace of inflation came in at some 2.5 per cent for February, the country’s stats office said, chipping away still further at the rationale for preventing rises in the koruna. (Since 2013, the CNB has prevented the euro from trading under CZK27 in an effort to deflect deflation. More explanation here.)

February’s increase was faster than the 2.2 per cent pace from January, and faster than the 2.4 per cent rate pencilled in by economists. It was also the highest rate since 2012.

Blame spuds (at least in part). The stats office says:

The month-on-month rise in consumer prices in ‘food and non-alcoholic beverages’ came primarily from the increase in prices of vegetables by 15.2%, of which prices of potatoes rose by 24.1% and prices of vegetables cultivated for their fruit increased by 28.1%. Prices of rolls and baguettes were higher by 4.9% and fruit by 1.8%. The growth of prices in ‘recreation and culture’ occurred primarily due to higher prices of package holidays by 4.5%. In ‘restaurants and hotels’, prices of catering services rose by 0.6%. In ‘transport’, the increase in prices of automotive fuel continued, although at a slower pace, and amounted to 0.7% in February.

“The end is nigh” for the exchange rate limit, writes Esther Reichelt at Commerzbank.

Nobody knows where EUR-CZK would trade if the CNB had not introduced the minimum exchange rate regime. We do not see convincing evidence that the exchange rate trend valid before the introduction should have changed substantially and therefore expect EUR-CZK to correct lower as the floor is abandoned. Given the exponential increase in the FX reserves required to defend the floor as inflation shoots up the pressure on the CNB to drop the koruna cap will increase substantially in the coming months.

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