Czech raises rate 6th time but signals it may pause

"At its meeting today, the Bank Board of the Czech National Bank increased the two-week repo rate to 4.50%, i.e. by 0.75 percentage point. At the same time, it increased the discount rate by the same amount to 3.50% and the Lombard rate to 5.50%. Five members voted in favour of this decision and two members voted for leaving rates unchanged.

The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast. Consistent with the forecast is a substantial rise in market interest rates at the start of this year. The Czech National Bank is thus continuing to respond to the combination of strong price pressures from the domestic and foreign economies, which are gradually passing through to domestic inflation. The interest rate increase will ensure that inflation returns close to the 2% the target at the monetary policy horizon and will help anchor inflation expectations.

Continuing production and supply chain problems and another wave of the pandemic are slowing the recovery of the global economy, including the euro area. However, the economic growth outlook for this year and the next is little changed compared with the previous forecast. A gradual easing of international logistics problems remains the key assumption. These effects, coupled with a jump in energy prices, are simultaneously fostering sizeable price pressures. This is reflected in a marked upward revision of expected producer price inflation and, to a lesser extent, also consumer price inflation in the euro area, especially this year. The slightly higher 3M EURIBOR outlook for 2023 reflects a shift in financial market expectations towards higher future inflation in the euro area and the related reaction by the ECB.

The Brent crude oil outlook has shifted slightly higher compared with the previous forecast, due to underproduction, more robust global demand and concerns about low global stocks and reserve capacity. However, the price of oil is expected to fall gradually from its current high levels this year and the next. The outlook for the euro-dollar exchange rate has moved towards a modestly stronger dollar but still assumes slight appreciation of the euro against the US currency.

The Czech economy will continue to recover from the pandemic this year. Despite more high numbers of positive cases, the forecast does not expect the introduction of measures having a significant dampening effect on domestic economic activity. Economic growth will continue to be driven largely by household consumption, although the initially high year-on-year growth of the latter will be due to last year’s low base. Households’ consumption expenditure will be funded by solid growth in disposable income and spending of the forced savings accumulated during the shutdowns of the economy. However, growth in consumer demand will be dampened by strong inflation and increased interest rates. Higher corporate investment will be motivated by continued growth in external demand, a shortage of workers on the domestic labour market and increasing wage costs. Government investment will also record growth, supported by absorption of EU funds. The problems in global production and supply chains, which are being felt strongly in the highly industrial Czech economy, will persist this year, resulting in higher additions to inventories. However, their impact on GDP will be smaller than in autumn last year and will gradually disappear during the second half of the year. As international trade gets going again, export growth will recover gradually and net exports will start to contribute to growth again. The Czech economy will grow by roughly 3% overall this year, similarly to last year. Economic activity will thus reach the pre-pandemic level by the year-end. Next year, economic growth will accelerate slightly.

Headline inflation will rise significantly further at the start of this year and exceed 9%, with all its components contributing to the increase. Core inflation will go up further. Traditional repricing in January, amid strong domestic demand, will reflect the sizeable previous growth in firms’ personnel and material costs and the recent rise in energy prices on commodity exchanges. The contribution of the costs of owner-occupied housing to core inflation will also remain significant. Moreover, the pick-up in inflation will be due significantly to a jump in administered price inflation on the back of the surge in energy prices and the end of the temporary waiver of VAT on electricity and gas. Food price inflation will also stay high in the first half of this year. Inflation will peak in the first half of this year. It will then start to fall gradually as growth in import prices and firms’ production costs slows, aided by an appreciating koruna, and as the stabilising effect of monetary policy manifests itself via domestic demand. Inflation will fall close to the Czech National Bank’s 2% target over the monetary policy horizon, i.e. in the first half of 2023.

Consistent with the winter forecast is a substantial rise in market interest rates, followed by a gradual decline from the second half of this year onwards. The rise in rates reflects a need to respond to the combination of exceptionally strong price pressures from the domestic and foreign economies. The monetary policy response to date will ensure that inflation falls towards the 2% target at the monetary policy horizon and will help anchor inflation expectations. The subsequent gradual decline in rates towards their long-run neutral level starting in the second half of this year reflects an expected decline in inflation pressures in the Czech economy in 2023 and once again firmly anchored inflation expectations. 

The exchange rate of the koruna will average CZK 24.50 to the euro in Q1. It will appreciate to CZK 24 to the euro in Q2, owing to a significantly positive interest rate differential vis-à-vis the euro area, and later stabilise just below this level.

By comparison with the autumn forecast, the inflation outlook is considerably higher for this year and slightly higher for next year. Economic growth was faster last year than expected in the autumn. By contrast, the growth forecast for this year and the next has been revised downwards. The outlook for domestic interest rates is higher for 2022 and 2023. Expectations regarding the koruna exchange rate are essentially unchanged.

The Bank Board assessed the uncertainties and risks of the new forecast at the monetary policy horizon as being significant and moderately inflationary overall. The possibility of weaker anchoring of inflation expectations to the CNB’s 2% target is an inflationary risk. Slower appreciation of the koruna as a result of a sharp tightening of monetary policy abroad or an escalation of the situation in Ukraine is a risk towards a slower or later decline in domestic interest rates. Conversely, the possibility of more modest growth in household consumption in response to the jump in energy prices and, to some extent, also consolidation of Czech public finances are downside risks to inflation. The uncertainties include the extent of repricing of goods and services this January and the duration of the overloading of global production and supply chains.

In view of the forecast and its moderately inflationary overall balance of risks, the Bank Board decided to increase interest rates by 0.75 percentage point. The interest rate increase aims to return inflation close to the Czech National Bank’s 2% target at the monetary policy horizon, i.e. 12–18 months ahead, and to help anchor firms’ and households’ inflation expectations. Future monetary policy steps will depend on incoming new information and future forecasts."

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