Euro lending to Czech companies on the rise. Yet this poses challenges for the central bank

Experts have attempted to model certain situations. They focussed particularly on the working capital of companies and their lending in euros. The study examines the impacts and models the transmission of various shocks and monetary policy, emphasising the role of exchange rate movements and the nature of shocks.

The outcomes indicate that the provision of loans in a foreign currency weakens the transmission mechanism of domestic policy for global supply inflation shocks. In other words, in order for the central bank to achieve the same inflation level, it has to increase rates more and tolerate somewhat larger production losses. The impact of lending in euros on monetary transmission for global demand shocks is then reversed. “Given the strengthening of the domestic currency, a weaker monetary policy response is needed, because a stronger currency puts downward pressure on corporate financing costs,” said one of the study’s authors, Volha Audzei.

The study also suggests that foreign shocks may also strengthen currency fluctuations, which affects corporate financing costs. However, loans in foreign currencies reduce feedback from the domestic monetary policy to the costs of corporate financing, which makes the domestic monetary policy somewhat more effective in fighting inflation. The transmission of monetary policy in response to global inflationary shocks, which impact both Czechia and the eurozone, depends on the nature of the shocks and exchange rate movements.

“Our findings stress the importance of taking into account corporate lending in euros when designing the monetary policy and the need for its authors to thoroughly identify the source and nature of shocks in order to effectively calibrate their response, said Audzei.