By Jason Hovet and Jan Lopatka
PRAGUE (Reuters) - The Czech central bank scrapped its cap on the crown currency on Thursday, allowing it to float freely to stronger levels against the euro for the first time since 2013.
The move means the crown could become much stronger against the euro, making euro zone goods cheaper in the Czech Republic but potentially putting a strain on the economy by making Czech manufacturing exports less competitive.
Market reaction was relatively mild ahead of a news conference by Central Bank Governor Jiri Rusnok at 1215 GMT.
The crown spiked around 1 percent immediately after the decision, hitting, 26.750 to the euro but dropped back to 26.93 later. It also traded weaker than the former cap's 27 per euro level for a time.
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This contrasted with a chaotic few minutes on markets after the Swiss National Bank surprised markets by dropping its cap in 2015.
The Czech central bank has signalled it was near to ending its cap, leading investors to bet billions of euros that the crown would strengthen.
But the central bank also reiterated it would be ready to step into the market if it needed to smooth excessive currency swings. It has said it would not reveal any potential intervention levels.
One Prague dealer said his bank had not yet seen the central bank in the market.
Markets had expected volatility in the crown after the exit due to the massive positions built up in the market.
"In the coming days, we expect elevated volatility. The exchange rate will be looking for a new equilibrium," said Michal Brozka, chief investment analyst with Raiffeisenbank.
"The first reaction to the exit is relatively muted and not requiring repeated action by the central bank. We expect firming in the crown toward 26.0 to the euro toward the end of the year."
Bond yields also rose, especially on short-term paper that foreign investors had used to build up positions betting on the crown in recent months. "There is a small sell-off on short bonds," a trader said.
The bank had signalled the end of the weak-crown regime was nearing when it had the last policy meeting on March 30 but left markets guessing when the move would come.
The decision follows a rise in inflation to 2.5 percent in February, above the bank's 2 percent target. The bank sees inflation rising closer to 3 percent later this year.
The central bank had been forced to boost its crown selling in the market in the past months as investors poured into the currency. It bought 47.8 billion euros into reserves between November 2013 and January this year, and billions more in February and March, according to the bank's data.
The bank left its main interest rate, the two-week repo rate, unchanged at 0.05 percent.
(Reporting by Jan Lopatka, Jason Hovet, Robert Muller, Petr Vodstrcilova; Editing by Jeremy Gaunt)
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