The Czech National Bank (CNB) raised its three main interest rates by 25 basis points, including the benchmark 2-week repo rate to 2.25 percent, the Lombard rate to 3.25 percent and the discount rate to 1.25 percent.
Pressure has been rising for the CNB board to hike rates in recent months, with two of the board's seven members voting to raise rates in the last three meetings to curb inflationary pressures.
Today another two members joined the earlier minority with the result that four voted to raise the rate while the remaining three members voted to leave rates unchanged.
This is the first rate hike by CNB since May 2019 when it paused in its tightening cycle that began in August 2017 after 8 rate hikes that raised the key rate by a total of 1.95 percentage points.
Inflation in the Czech Republic has topped the central bank's 2.0 percent midpoint target since May 2018 and in December inflation rose further to 3.2 percent, the highest since October 2012, and higher than CBN had expected.
CNB, which targets inflation of 2.0 percent within a tolerance range of plus/minus 1 percentage points, expects inflation to rise further at the start of this year, partly due to government measures to boost household consumption.
"Domestic inflation will increase appreciably above the upper boundary of the tolerance band around the target in the months ahead, mainly due to the price impacts of changes to indirect taxes amid persisting elevated inflation pressures in the domestic economy," CNB said.
The CNB raised its forecast for annual inflation to average 2.3 percent in the first quarter of 2021 from an earlier forecast of 2.1 percent, before easing to 2.1 percent in the second quarter as inflationary pressures weaken, mainly due to slowing wage growth, falling growth in administered prices, and food prices.
Economic growth in the Czech Republic slowed in 2019 and is seen slowing further this year before it gradually accelerates in 2021, helped by an a gradual improvement in economic growth in the euro area along with rising consumption spending by households.
"The current downturn in private investment, reflecting the slowdown in euro area economic growth, will drop out during this year and total investment growth will turn positive again," CNB said.
Growth in 2019 is estimated at 2.5 percent and is seen slowing to 2.3 percent this year, down from its previous forecast of 2.4 percent, before picking up in 2021 to 2.8 percent.
The Czech koruna, which has risen since October last year, jumped in response to the rate hike to just above 24.9 to the euro from 25.0 before it settled slightly lower just above 25.0.
During five years of extraordinary easy monetary policy from November 2012 to August 2017, the CNB not only cut its key rate to a rock-bottom 00.5 percent, but also intervened in the foreign exchange market to keep the koruna from rising against the euro as an addition tool of monetary easing.
As a first step toward tightening its monetary policy stance, CNB in April 2017 scrapped its commitment to keep the koruna below 27 to the euro. The koruna immediately soared before easing and settling around 25.8 to the euro between July 2018 and October last year.
Since then the koruna has been rising steadily and has now broken the psychological barrier of 25 to the euro, a level not seen since 2012.
CNB expects the koruna-euro exchange rate to remain stable for the rest of this year and then appreciate only slightly in 2021.
The Czech National Bank released the following statement:
"At its meeting today, the Bank Board of the Czech National Bank increased the two-week repo rate by 25 basis points to 2.25%. At the same time, it increased the Lombard rate to 3.25% and the discount rate to 1.25%. Four members voted in favour of this decision, and three 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 rise in domestic market interest rates initially, followed by a decline in the second half of this year.
According to the external assumptions of the new forecast, the currently muted economic growth in the effective euro area will be replaced by a gradual acceleration during this year. The recovery in economic growth will be reflected in a gradual increase in foreign producer price inflation. Consumer price inflation in the effective euro area will be below 2% over the entire forecast horizon. The market outlook for short-term euro rates has shifted to less negative levels.
According to the assumptions, the price of oil will fall gradually from an initial level of around USD 65 a barrel. However, world prices of oil have decreased markedly in recent days and are now below the assumptions of the forecast. The euro is expected to appreciate only marginally against the dollar.
Domestic inflation will increase appreciably above the upper boundary of the tolerance band around the target in the months ahead, mainly due to the price impacts of changes to indirect taxes amid persisting elevated inflation pressures in the domestic economy. These pressures will temporarily increase further at the start of this year, among other things as a result of government measures boosting household consumption. They will subsequently weaken gradually, mainly due to slowing wage growth. A temporary decline in import prices and falling growth in administered prices and subsequently food prices will also have an anti-inflationary effect. Inflation will thus decrease close to the 2% target over the monetary policy horizon, i.e. in the first half of next year. However, the decrease in inflation will be slowed by the assumed price impacts of changes to indirect taxes.
Monetary policy-relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will be lower than headline inflation and will return to the 2% target over the monetary policy horizon. This will be supported by a tightening of the monetary conditions at the start of this year.
The growth of the Czech economy slowed in 2019 but will gradually accelerate on the back of a steady recovery in external demand. GDP growth will continue to be driven mainly by rising consumption expenditure of households, reflecting continued, albeit gradually slowing, growth in household income. Fiscal policy will contribute to domestic demand growth via a rise in public sector pay, pensions and other social benefits. Government investment expenditure will also increase, supported by drawdown of EU funds. The current downturn in private investment, reflecting the slowdown in euro area economic growth, will drop out during this year and total investment growth will turn positive again. The recovery in external demand will be reflected in positive contributions of net exports to growth. As a result, economic growth will accelerate gradually and moderately. The unemployment rate will remain close to its current very low levels. Amid persisting labour shortages and weakening demand for labour, employment growth will remain subdued. Wage growth will decrease gradually, but its slowdown will be dampened by a further large increase in both the minimum wage and salaries in the non-market part of the economy from January 2020.
After appreciating at the start of 2020, the koruna-euro exchange rate will remain stable for the rest of the year. The effect of a temporary widening of the interest rate differential vis-à-vis the euro area will be offset by only weak economic and price growth abroad, amid only gradually fading negative global sentiment. Next year, the exchange rate will appreciate only slightly. Continued real convergence of the Czech economy will foster appreciation over the entire forecast horizon.
Consistent with the forecast is a rise in domestic market interest rates initially, followed by a decline in the second half of this year. The initial increase in interest rates mainly reflects persisting increased domestic inflation pressures, which will be temporarily intensified by a further large increase in the minimum wage and other government measures fostering growth in household consumption. The expected second-round effects of changes to indirect taxes, which will affect inflation in 2020 and early 2021, are also pushing up rates. The subsequent slight decline in domestic interest rates in the forecast will reflect a decrease in domestic inflation pressures in an environment of still very easy monetary policy in the euro area.
The headline inflation outlook has been increased by comparison with the previous forecast, owing to a revision of fundamental domestic inflation pressures, faster growth in administered prices and the incorporation of new changes to indirect taxes in 2021. The forecast for growth in domestic economic activity is slightly lower for this year and unchanged for next year. The new forecast predicts marginally higher interest rates in 2021 than the previous one did. Compared with the November forecast, the exchange rate of the koruna will be stronger this year.
The Bank Board assessed the balance of risks to the inflation forecast at the monetary policy horizon as being broadly balanced. The future exchange rate path is an anti-inflationary risk to the forecast. The external assumptions of the forecast continue to include the risk of a potential slower recovery of external demand growth. Potential higher inflation due to stronger domestic inflation pressures is an upside risk to the forecast."
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