Czechia Watch: Another inflation surprise adds pressure on CNB

Czech inflation data for August surprised to the upside and fits the picture of the latest surprises in Poland and Hungary. Compared to July, prices grew by 0.7%, which is unusually large for this time of the year. The increase in prices was broad-based across the consumer basket. As a result, the year-on-year dynamics jumped from 3.4% to 4.1% compared to our and consensus forecast of 3.6%. According to our projections, the peak is yet to come. Even if the month-on-month dynamics will gradually ease, inflation is set to surpass 4.5% towards the end of the year.

Regarding the driving forces of inflation, not much has changed since the last reading. Prices are still pushed up by a combination of supply-side price pressures and strong demand. The latter is driven by deferred consumption, excess savings and a strong labour market. Services prices are still adapting to the lively dynamics between supply and demand. As a result, there is upward pressure on core inflation, which was at 3.8% in July, but our preliminary estimate points to acceleration to 4.6% (data to be yet released by the CNB).

Food prices were expected to decelerate in August compared to June due to usual seasonal effects. In fact, however, food prices were slightly higher than in the previous month and thus did not deliver the anticipated slowdown to the monthly inflation increment.

Much of the price pressures are linked to the pandemic and the effects of reopening and are therefore transitory. Notably, base effects will fall out of the year-on-year comparison and the disrupted price dynamics in services is expected to normalize gradually. On the flip side, there are signs of more persistent inflationary pressures, which are, for example, reflected in increasing prices in the housing category. One also has to consider the better than expected situation on the labour market, where there are already signs of overheating.

This has implications for the CNB. Mounting price pressures mean that inflation comes increasingly to the forefront, while any possible cautiousness regarding slower than anticipated GDP growth in 2Q21 or delta concerns is pushed further into the background. The August CPI surprise validates a rate hike at the next meeting which takes place in three weeks. The question now is about the size of the hike. At the last monetary meeting, two members voted for rate stability, one for a 50bps hike while the remaining four called for 25bps. With today's CPI release, we place our interest rates path projection under revision.