Czech Rep. becomes 2nd EU nation to raise rates

     The Czech Republic joined fellow European Union (EU) member Hungary by raising its benchmark interest rate and said monetary policy was now "probably" entering a phase of rising interest rates, which "can therefore be expected to continue rising in the second half of the year."

     The Czech National Bank (CNB) raised its two-week repo rate by 25 basis points to 0.50 percent along with the Lombard rate, which was raised to 1.25 percent. The discount rate was unchanged at 0.05 percent.

      The decision was largely expected and four of the bank's board members voted for the hike, one member voted to raise the rate 50 basis points while two voted to keep rates unchanged.

     "The Bank Board assessed the uncertainties and risks of the spring forecast as being slightly inflationary overall," CNB said, adding the more favorable than expected course of the pandemic will contribute to a faster economic recovery.

      Among the factors acting in an inflationary direction, CNB pointed to higher-than-expected growth in wages, higher industrial producer prices abroad, a higher outlook for administered prices and higher-than-expected oil prices      

      CNB's rate hike comes on the heels of Hungary's rate hike earlier this week as central banks, especially in emerging and developing economies, begin to roll back the extraordinary easing of monetary policy last year in response to the pandemic.

      So far this year, 16 central banks have raised their rates a total of 26 times - including Turkey, Brazil, Russia, Hungary and now the Czech Republic - as they seek to keep a lid on inflation that is accelerating in response to the bounce-back in demand after lockdowns and higher commodity prices, such as oil.

      Today's rate hike marks the CNB's second step toward normalizing its monetary policy stance, which was loosened sharply last year in response to the COVID-19 pandemic.  

     The first step came last month when CNB decided to raise the countercyclical capital buffer applied to banks, a move it described as a "logical step arising from the fading of the acute phase of the economic downturn."

      In addition to three rate cuts last year in quick succession - two in March and a third in May by a total of 200 basis points - the central bank had also slashed the capital buffer for banks twice to boost their ability to lend.

     Only a month before the pandemic swept through the world and CNB began easing its policy, the central bank had been on a tightening path to curb rising inflation.

      In February last year the central bank raised its rate for the 9th time since August 2017 - the rate was raised by a total of 2.20 percentage points - as it extended a tightening cycle to curb rising inflation.

     But the hit to economic activity from the shutdown of the global economy to prevent the spread of the pandemic quickly led to a fall in inflation. 

     After hitting 3.4 percent in July last year, inflation decelerated to 2.1 percent in February this year.

     But since then inflation has picked up speed and in early May the bank forecast a rise in interest rates from roughly the middle of this year and onwards as it raised its inflation forecast despite continued uncertainty over how the economy would recover from the pandemic.

      The first step toward tightening, then came in late May when CNB that CNB's raised the countercyclical capital buffer for banks in late May by 50 basis points to 1.0 percent as of July 1, 2022, saying this was a logical step as the country's economy had now come through the acute phase of the economic downturn. 

     CNB also reduced the frequency of 2-week liquidity-providing repo operations to once a week.

     In April, inflation jumped to 3.1 percent but then eased to 2.9 percent in May, within CNB's tolerance range of 2.0 percent, plus/minus 1 percentage points.

     In its latest forecast, CNB said inflation is expected to fluctuate around the upper boundary of its tolerance range in coming quarters and then return close to its target next year, helped by an unwinding of currently elevated growth in import prices and higher monetary conditions.

     At the end of May, the bank's governor, Jiri Rusnok, confirmed what financial markets were beginning to expect when he said the country's economy no longer needed support from loose monetary policy, boosting expectations that rates would be raised today.

     The Czech koruna, which fell last week as most other currencies in response to the jump in the U.S. dollar, continued its bounce after the rate hike and was trading at 21.3 to the dollar, unchanged on the year. Against the euro, the koruna rose after the rate hike but then gave back some of its gains.

     The koruna was trading at 25.4 to the euro, up 3.1 percent this year.

     The Czech National Bank issued the following statement:

"Statement of the Bank Board for the press conference following the monetary policy meeting

At its meeting today, the Bank Board of the Czech National Bank increased the two-week repo rate by 25 basis points to 0.50%. At the same time, it increased the Lombard rate to 1.25% and kept the discount rate unchanged at 0.05%. Four members voted in favour of this decision, one member voted for increasing the two-week repo rate by 50 basis points and two members voted for leaving rates unchanged.

This decision of the Bank Board is underpinned by the spring macroeconomic forecast and by an assessment of information obtained since it was prepared. Consistent with the forecast is a rise in market interest rates from roughly the middle of this year onwards. The Bank Board assessed the risks and uncertainties of the forecast as being slightly inflationary overall.

The current outlook for GDP growth in the effective euro area has increased, especially for this year. This is due to the earlier easing of the anti-pandemic measures in the euro area countries than assumed by the current forecast. The outlook for foreign industrial producer prices – especially for this year – has moved upwards significantly. This is due in roughly equal measure to the core and energy components of producer prices. The increase in the energy component is being driven mainly by the continued rise in oil prices. The outlook for growth in the core component of producer prices has been revised upwards due to the overloading of global production and supply chains abating later. The outlooks for consumer price inflation in the effective euro area and foreign interest rates have been revised marginally upwards.

The Brent crude oil price exceeded USD 70 a barrel in June and its outlook shifted appreciably above the assumptions of the current forecast. The expected euro-dollar exchange rate is virtually unchanged compared with the forecast.

In line with the spring forecast, domestic inflation has been close to the upper boundary of the tolerance band in Q2 so far. As expected, core inflation remained elevated in April and slowed slightly in May. Consumer price inflation in this segment continued to be driven by a still solid income situation of households accompanied by strong inflation pressures from abroad. Growth in food prices remained highly volatile. Fuel prices switched to strong growth in Q2, mainly on account of base effects caused by the drop in oil prices during the first wave of the pandemic. According to the spring forecast, inflation will fluctuate around the upper boundary of the tolerance band in the quarters ahead and return close to the CNB’s 2% target next year. This will be aided by an unwinding of the currently elevated growth in import prices and an expected tightening of monetary conditions.

In Q1, the Czech economy faced the most stringent anti-epidemic measures so far. Despite this, GDP fell only slightly in quarter-on-quarter terms and its year-on-year decline was less pronounced than the spring forecast had expected. This was due mainly to a larger-than-forecasted contribution of gross capital formation and, within it, unexpectedly strong additions to inventories in particular. This was counteracted by a surprisingly negative contribution of net exports. A slight year-on-year increase in government consumption and a sharp year-on-year decline in household consumption were broadly as predicted. The spring forecast assumes that the economy started to recover in Q2. The Czech economy will thus return to growth overall this year, but the year-on-year dynamics of GDP will be highly volatile over the course of the year. Economic growth will pick up appreciably next year.

Following a recovery in March, year-on-year growth in industrial production accelerated sharply in April, aided significantly by base effects. By contrast, construction remains in a downturn. In early spring, retail was still restricted by the anti-epidemic measures. As in the case of industry, the faster growth in retail sales in April was due largely to last year’s low base.

Despite the worst pandemic wave so far, the labour market situation did not deteriorate further in Q1. The slight increase in the general unemployment rate was in line with the forecast, and the share of unemployed persons in April and May was slightly lower than forecasted. Wage growth in market sectors was above the spring forecast owing to faster growth in the fundamental component of wages. By contrast, wage growth in non-market sectors lagged significantly behind the forecast. As a result, the expected overall wage growth broadly materialised.

The koruna appreciated swiftly to CZK 25.4 to the euro in the first half of May. This was fostered by an inflow of foreign short-term capital into koruna assets, primarily reflecting a marked improvement in the epidemic situation at home and in most EU countries. The koruna has thus so far been slightly stronger in Q2 compared with the spring forecast. According to the forecast, the koruna will continue to firm gradually.

The spring forecast was drawn up in an environment of elevated risks and uncertainties but has been materialising relatively well so far. The significantly smaller-than-expected year-on-year decline in economic activity in 2021 Q1 is good news. Inflation and average wage growth were in line with the forecast in May. The share of unemployed persons was slightly below the forecast in April and May.

The Bank Board assessed the uncertainties and risks of the spring forecast as being slightly inflationary overall. The more favourable than expected course of the pandemic will contribute to a faster recovery of the domestic real economy. An updated outlook for the external environment, higher-than-expected growth in domestic fundamental market wages at the start of the year and a higher outlook for administered prices next year are acting in the inflationary direction. Conversely, the Bank Board identified the stronger-than-expected exchange rate of the koruna in recent months as an anti-inflationary risk. A renewed deterioration of the epidemic situation during the autumn cannot be ruled out either. Given the swift progress of vaccination, however, this should not lead to across-the-board restrictions being reintroduced in the economy. With the present decision, monetary policy is probably entering a phase of gradual growth in interest rates, which have been very low up to now. Interest rates can therefore be expected to continue rising in the second half of this year."

     www.CentralBankNews.info