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Czechia Watch: Hawkish resumption of the rate cut cycle
After the stability in December, the Czech National Bank's board, in line with our and market forecasts, resumed the monetary policy easing and cut rates by 25bps at its first meeting of the year. The key interest rate will thus decline to 3.75% as of tomorrow.
All seven members of the bank board voted in favour of this decision. Throughout the day, the koruna slightly strengthened towards 25.10 EUR/CZK following the flash estimate of the January inflation, which slightly increased the probability of continued rate stability. After the announcement, the koruna began to move towards the level of 25.15 EUR/CZK, but during the press conference, it started to strengthen again.
At the subsequent press conference, Governor Ales Michl revealed that January inflation was above the CNB's estimates, which predicted a drop of inflation to 2.5%. He also mentioned that this result could indicate higher inflation than anticipated by the analytical apparatus in the CNB's new macroeconomic forecast. The monetary section has also prepared two alternative scenarios, with the first accounting for a sustained increase in service prices and significant food price hikes. The second scenario assumes a worsening foreign demand and persistent inflation pressures in the domestic economy. The CNB expects an average inflation rate of 2.4% in the baseline scenario.
Inflation will be pushed upwards by food and service prices. This assessment aligns with our prediction of an average inflation rate of 2.5%. The bank board continues to assess risks as slightly inflationary, with the governor specifically citing service prices, food prices, and, in the long term, a tight labour market, excessive credit activity, and government budget deficits. Therefore, it is more likely that the bank board will maintain interest rates at a restrictive level for a longer period than indicated by the trajectory of interest rates in the new macroeconomic forecast. According to that forecast, the 3M PRIBOR is expected to be around 3% by mid-year and stable at that level. However, the governor clearly indicated that the room for further rate cuts is relatively limited and real interest rates will remain positive. This corresponds with our belief that the bank board will proceed very cautiously and will only cut rates once more this year (during the second quarter); after that, rates will be held at 3.50% for an extended period. Thus, monetary policy will remain tight despite the economy operating below its potential. The CNB expects the growth of the Czech GDP to reach exactly 2% this year (our estimate is 2.1%), mainly due to increasing household consumption due to the continued rise of real wages. On the other hand, the contribution of net exports will be negative. Next year, economic growth is expected to accelerate to 2.4% (also our estimate).
The CNB's decision itself was not surprising, but the subsequent press conference, which explicitly stated a very cautious approach to future meetings, caused the koruna to strengthen below the level of 25.10 EUR/CZK. Our forecast assumes that the bank board will only cut rates once more this year and will reach its considered terminal level (3%) only in 2026.
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Martin KRON
Czech Republic Martin is a macroeconomic analyst at Raiffeisenbank in the Czech Republic. Martin studied economic policy as a major at the Faculty of Economics and monetary economics and banking as a minor at the Faculty of Finance and Accounting of the Prague University of Economics and Business. After the graduation in 2021 he started to work in Department of Financial Management at Ministry of Culture. Since June 2023 he has joined the economic research team located in Prague. With his academic background he is very interested in the monetary and the fiscal policy and their impact on the economic performance. He is a passionate sport fan so in his free time he enjoys playing mostly tennis and football with his friends.
Year-on-year inflation surprisingly remained within the Czech National Bank's (CNB) tolerance band in December, rising from November's 2.8% to the current 3%. |
At yesterday's meeting, the CNB's Bank Board decided to keep interest rates unchanged (key rate at 4%) for the first time since the monetary policy easing cycle began last December. |
Year-on-year inflation remained within the CNB's tolerance band even in November. Our and market estimates anticipated an increase to 3% with a potential risk of rising above this level. However, November inflation ultimately remained at 2.8%, the same as in October. |
As expected, annual consumer price inflation jumped higher again. In October, it increased from 2.6% to 2.8%, which was in line with the median market estimate. Our forecast expected a slightly more modest increase (2.7%). |
At Thursday's meeting, the CNB Bank Board confirmed market expectations by cutting interest rates by 25bp, which was also in line with our own forecasts. |