Archived Currency Reports

Currency Report - December 2013

Following a meeting of the Hrvatska Narodna Banka board in November the central bank published a press release summarising its view of the Croatian economy. Its assessment was not unreservedly positive. The "mild recovery in the second quarter" of 2013 and "more favourable developments in the euro zone... do not suggest a permanent [upward] turn." Whilst the Bank "maintains an expansionary monetary policy" with interest rates on short-term government borrowings at "a historic low", lending to households and businesses remains restrained for the same reasons it does in Britain: Lenders are more cautious because of their recent experience of bad loans and borrowers are holding back because their confidence has been severely dented by five years of recession.

But the central bank also notes that "the kuna/euro exchange rate is stable". That comment is instructive because it offers a clue to the Bank's comfort levels. In the last six months the kuna strengthened from 7.57kn per €1 to 7.44kn then retreated to 7.65kn. That represents a 1.8% increase followed by -2.1% fall, or a variation of ±1.4%. More importantly the HNB's "stability" also appears to allow for a gentle decline of the kuna against the euro. In 2010 it averaged 7.28kn per €1, in 2011 7.42kn, in 2012 7.51kn and in the last 12 months 7.57kn. That trend, and the HNB's professed comfort with it, extrapolates to an average rate of 7.67kn per €1 for 2014. (Bear in mind, of course, that past performance in financial markets is never a guarantee of future performance.)

For investors in the euro zone then, the cost of buying into Croatia is becoming slightly cheaper over time. From the British investor's standpoint however, it has not been a one-way street. In the last 12 months the average exchange rate has fallen from 9.21kn per £1 to 8.92kn. That setback was the result of sterling's sharp fall at the beginning of the year, when the pound dropped from €1.23 on Christmas Day to €1.16 on Valentine's Day, a -6% decline.

Since then the pound has staged a modest recovery. In large part that has been because the statistical data show the UK's economic recovery to be more robust than in Euroland. Having been told in August by the Bank of England governor that sterling interest rates will not go up before unemployment falls to 7%, investors have persuaded themselves that a 7% unemployment rate will trigger an increase in the Bank Rate. Never mind that this is not what the governor said; it is what the market thinks.

Meanwhile in Euroland interest rates have been heading the other way. Following an unexpectedly sharp fall in euro zone inflation to 0.7% the European Central Bank halved its benchmark Refinancing Rate to 0.25% in early November. Since then there has been a report that the ECB is considering applying a negative rate of interest to the deposits placed with it by commercial banks. A negative interest rate is when depositors do not receive interest, they pays it. Needless to say, the prospect of negative interest does not go down well with investors.

Looking at the whole picture, there is a reasonable chance that the kuna will continue to drift lower against the euro and that sterling will gradually build on its gains against the euro. A reasonable chance. On the other side of that coin is sterling's world-class ability to pluck defeat from the jaws of victory. At current levels there is good reason for sterling-based investors to take precautions by hedging any anticipated requirement for euros or kuna, fixing a price today for a proportion of what they need. To paraphrase Vegetius; those looking for a stronger pound should prepare for it to weaken.

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