In April the Czech National Bank (CNB) took the first step toward normalizing its monetary policy by abandoning its commitment from November 2013 to keep the koruna from exceeding to 27 to the euro as an additional tool to stave off deflation.
This move to cap the koruna's exchange rate followed the CNB's cut to the current level of the repo rate, essentially zero, in November 2012.
"Interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna," the CBN said.
In May the CNB forecast that interest rates will move higher in the third quarter of this year and 2018, with the 3-month PRIBOR (the Prague interbank market rate) rising to 0.8 percent from 0.5 percent this year. This 2018 forecast was lowered from its previous forecast of 1.1 percent, with any rate increases dampened until mid-2018 due to asset purchases by the European Central Bank.
"The CNB Bank Board assessed the risks to the current inflation forecast at the monetary policy horizon as being slightly inflationary," the CBN said, adding that in the quarters ahead the exchange rate of the koruna may be weaker than forecast due to the closing of koruna positions by investors.
In contrast, lower oil prices pose an anti-inflationary risk to the forecast," the CNB said.
The Czech National Bank issued the following statement:
"At its meeting today, the Bank Board of the Czech National Bank decided unanimously to keep interest rates unchanged. The exit from the exchange rate commitment in April was the first step towards a gradual return of the overall monetary conditions to normal. Interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna.
According to the current forecast, inflation will stay in the upper half of the tolerance band around the target for the rest of this year. It will decline towards the 2% target at the start of next year. Inflation will remain very close to the target at the monetary policy horizon, i.e. in 2018 Q2 and Q3. Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3 and later also in 2018. The Bank Board assessed the risks to the current forecast as being slightly inflationary.
Economic activity in the Czech Republic’s main trading partner countries is continuing to rise at a solid pace. Its outlook for this year increased slightly, reflecting faster growth at the start of this year and favourable leading indicators for Q2. Producer price inflation also shifted slightly upwards for this year. Next year, however, the effect of the increase in commodity prices will unwind and producer price inflation will then ease to the levels expected in our current forecast, i.e. towards 2%. The outlook for euro area consumer price inflation remains virtually unchanged. Inflation will thus increase only very gradually and will not approach the European Central Bank’s target from below until the close of next year. While the outlook for the three-month EURIBOR is unchanged for this year, it is marginally lower for next year.
The market outlook for the Brent crude oil price declined to around USD 51 a barrel owing to continuing excess supply. According to market outlooks, the oil price will stay close to this level until the end of next year. Currently, it is significantly lower. The market outlooks for the euro-dollar exchange rate have shifted towards a slightly stronger euro. This is also a slight anti-inflationary factor as regards koruna prices of oil.
Domestic inflation edged down compared to the end of Q1. In May it stood at 2.4%, i.e. 0.2 percentage point below the forecast. This was due mainly to slightly slower growth in food prices and a more marked slowdown in annual fuel price growth compared to the forecast. By contrast, core inflation continued to increase and was slightly higher than forecasted. It still visibly reflects the continued growth in the domestic economy and wages.
Inflation pressures are also evident in other price categories. Prices in manufacturing are increasing at a relatively strong pace, although a moderation was observed in May. Growth in agricultural producer prices reached double figures. Construction work prices and market services prices are also rising steadily.
In line with expectations, the growth of the Czech economy accelerated in 2017 Q1, reaching almost 3%. GDP growth was 0.4 percentage point higher than forecasted. This was due mainly to a less pronounced decrease in fixed investment and inventories and, to a lesser extent, to faster growth in government consumption. Conversely, the contributions of household consumption and net exports were lower than forecasted. However, these two demand components maintain a dominant share in GDP growth.
The data available for 2017 Q2 point to continued solid growth in retail sales and industrial production. Construction output also saw pronounced recovery in April for the first time in a long time. The economic sentiment of both households and corporations remains high.
The unemployment rate in the Czech Republic fell slightly further in 2017 Q1. The share of unemployed persons has come down somewhat again in Q2 so far and is approaching 4%. Wage growth in market sectors surged in 2017 Q1, reflecting the robust economic growth and increasing labour market tightness. Wages in non-market sectors have also been rising apace for some time now. The April wage data suggest a further increase in wage growth.
To sum up the important facts about recent developments in the Czech economy, inflation was slightly below the forecast in May. Conversely, the growth rates of GDP and the average wage in 2017 Q1 were higher than forecasted. The share of unemployed persons was in line with the forecast in April and May.
The CNB Bank Board assessed the risks to the current inflation forecast at the monetary policy horizon as being slightly inflationary. The observed stronger growth in domestic economic activity and wages may act in this direction. The koruna exchange rate remains a significant source of uncertainty. In the quarters ahead, it may be weaker than forecasted owing to the closing of koruna positions by financial investors amid the absence of a counterparty for these transactions. By contrast, lower current and expected oil prices pose an anti-inflationary risk to the forecast. In view of the message of the current forecast and the balance of its risks, it is likely that the CNB will increase interest rates in line with the prediction."
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