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cee money-qe option on table as czech rates near zero

fortified by its reputation as an inflation tamer, the czech central bank may prove better placed than most in emerging economies to follow the u.s. fed, the bank of england and the bank of japan in experimenting with money-printing.

it could even look to emulate the swiss national bank in weakening its currency's value, given that the czech republic's success as an exporter to the euro zone makes it similarly vulnerable to recession triggered by the currency bloc's debt crisis.

with the czech economy already shrinking, the central bank (cnb) is running out of conventional ways to encourage people to borrow and spend after chopping interest rates close to zero.

the government has cut spending and raised taxes to maintain the country's reputation as a safe place to invest and czechs, never the most happy spenders, have slashed consumption.

policymakers have avoided any collapse in market confidence and debt yields have dropped to all-time lows, but now the combination of domestic austerity and the euro zone crisis requires creative thinking in monetary policy.

analysts said the central bank may soon cut its key two-week repo rate from 0.5 percent to zero or even negative territory and consider injecting money into the economy.

although the conservative bank is unlikely to make any drastic move, there are a few options to consider.

it could start curbing or halting its regular liquidity-draining tenders, sell the crown in the foreign exchange market, buy bonds, or cut its lombard overnight lending rate to lower the ceiling on interbank rates.

chief emerging markets economist at capital economics neil shearing said the bank could cut its 2-week sterilising repos, in which it takes some 360 billion czech crowns ($18 billion) out of circulation.

"we are suggesting... that the cnb stops absorbing excess liquidity in the banking system - in other words it lets the monetary base expand, a form of qe (quantitative easing)," shearing said.

"if a further expansion of the monetary base is warranted, we're suggesting that unsterilised purchases of foreign exchange would be a good place to start, given how open the economy is."

crown question

the czech central bank's success in keeping inflation and interest rates low relative to other economies in the region has often encouraged traders to use the crown as a funding currency, to be borrowed to buy assets offering higher returns.

policy in past years has sought to balance the rival needs of keeping the crown at a level that helps exporters compete while keeping inflation under control.

the crown has gained 2.5 percent this year to 24.92 to the euro, lagging 9 percent gain to the zloty and 13 percent rise in the forint this year.

yet it may still be worth considering interventions against the crown, mainly to increase the supply of domestic currency. this would have the bonus of helping exporters while posing little inflationary risk given that consumers and businesses are so cautious, analysts say.

the bank has already flagged it is ready to use additional policy instruments but gave little indication of what to expect.

"we are ready to implement and use (any) tools that are described in all books on the economic theory and are tested by other central banks, in order to meet our role ... and meet the inflation target," vice governor vladimir tomsik said following the bank's last rate-setting meeting on aug. 2.

in a bloomberg interview on aug. 16, tomsik also said: "it would make sense to use (those) additional instruments that wouldn't be about quantitative effects but about decreasing the long end of the yield curve."

some analysts said tomsik could mean sterilised bond buying but others questioned that, given record low bond yields.

the market has already priced a 25 basis point cut in the two-week repo rate used to drain surplus liquidity on sept. 27.

the bank slashed its 3-month market rates forecast for next year in its august outlook to 0.3 percent from 1.0 percent, which suggests that the repo rate could drop below zero.

the swedish and danish central banks have used a negative interest rate on bank deposits.

tomsik said following the august rate meeting it was "a big question" whether to deploy a negative repo rate and analysts said it would probably be the bank's last choice.

'hoarding money'

the bank's options are somewhat different from many developed markets, such as the united states or the euro zone, where central banks supply liquidity to the banking sector.

the czech banking market has enjoyed a growing liquidity surplus, helped by capital inflows since the economy emerged from communism. the central bank sterilises the liquidity in its regular repo tenders and hence flooding the market with additional money may seem ineffective.

but some economists said surplus liquidity was not an argument against quantitative easing.

the central bank "needs to reduce the hoarding of money," said lars christensen, chief analyst at danske bank. "banks are holding large reserves because the economy is deflationary."

banking sector capital adequacy was 15.3 percent of risk weighted assets at the end of 2011, nearly double the eu-prescribed level, highlighting the defensive approach of banks. the loan-to-deposit ratio was just 73 percent.

christensen said an option for the cnb was to follow the swiss central bank and set a temporary cap on the crown at around 30.00 versus the euro.

but some analysts say the bank will be cautious.

"post-modern measures are likely to come only once we see a meaningful additional euro zone shock and then after rate cuts, the timing of which is still highly uncertain," said peter attard montalto, an economist at nomura.

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