The Czech National Bank (CNB) has now raised its rate by 45 basis points this year following a 20 point hike in August, its first rate hike since February 2008.
At its meeting in September, the CNB's board paused but issued the same guidance as today. Today's rate hike was unanimously approved by the seven board members.
In addition to raising the two-week repo rate, the Lombard rate was raised by 50 basis points to 1.0 percent while the discount rate was maintained at 0.05 percent.
The rate hike was underpinned by an update to the CNB's forecast that includes slightly higher inflation, economic growth and interest rates.
"A majority of the bank board assessed the balance of risks to the current forecast at the monetary policy horizon as being slightly inflationary," the CNB said, pointing to the risk that the exchange rate of the Czech koruna may rise at a slower rate than expected as investors unwind speculative positions built up in anticipation of tighter monetary policy.
Another risk to inflation stems from the strength of the Czech economy and higher wages.
The CNB raised its forecast for economic growth this year to 4.5 percent from 3.6 percent previously forecast and the 2018 forecast to 3.4 percent from 3.2 percent.
In the second quarter of this year the Czech Gross Domestic Product jumped by an annual rate of 4.7 percent from 3.0 percent in the first quarter, driven by robust household consumption and income on the back of rising investment and demand from trading partners.
"An increasing shortage of available labour force will cause employment growth to slow and wage growth to accelerate further," the CNB said, adding: "There is little room for unemployment to decrease further."
The unemployment rate fell to a 2017-low of 3.8 percent in September.
Inflation in the Czech Republic has been accelerating in the last year and hit 2.7 percent in September, the highest since October 2012, two months before the CNB slashed its rate to a record low of 0.05 percent.
The year after the central bank then began using the exchange rate as an additional monetary policy tool and made its first shift toward higher policy in April this year by abandoning its commitment to keeping the koruna from rising above 27 to the euro.
The CNB raised its fourth quarter 2018 inflation forecast to 2.2 percent from 1.8 percent and the first quarter 2019 forecast to 2.0 percent from 1.8 percent. The CNB targets inflation of 2.0 percent.
Since abandoning its pledge to hold down the koruna's exchange rate, the koruna has gained strength against the euro, supported by the European Central Bank's (ECB) decision last week to continue its asset purchases - known as quantitative easing - next year.
"According to the forecast, the koruna will appreciate further against the euro, owing mainly to monetary policy being tightened sooner in the Czech Republic than in the euro area," CNB said, adding that it will renew its exchange rate forecasts next year.
The koruna was trading at 25.7 to the euro today, slightly down on the rate hike, but 5 percent higher on the year.
The Czech National Bank issued the following statement:
"At its meeting today, the CNB Bank Board decided unanimously to increase the two-week repo rate by 25 basis points to 0.50%. At the same time, it increased the Lombard rate by 50 basis points to 1.00% and kept the discount rate unchanged at 0.05%.
The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast of the Czech National Bank. Consistent with the forecast is a continuing rise in domestic market interest rates. According to the forecast, inflation will stay above the 2% target for most of 2018. It will then return to the target at the monetary policy horizon, i.e. in late 2018 and early 2019.
According to the assumptions of the new forecast, economic growth in the effective euro area will accelerate further over the rest of this year. It will maintain a faster pace in the next two years. Growth in industrial producer prices will weaken in the months ahead, due mainly to a stronger euro-dollar exchange rate and an unwinding of the previous increase in commodity prices. However, it will then accelerate again. Consumer price inflation will follow a similar pattern, falling initially and then approaching 2% only gradually from below. 3M EURIBOR market rates are negative over almost the entire outlook on account of the European Central Bank’s still easy monetary policy. The outlook for the euro-dollar exchange rate lies close to the current levels, i.e. just below USD 1.2 to the euro, until the end of 2019. The price of Brent crude oil should be close to USD 55 a barrel.
Domestic inflation will stay above the 2% target, but within its tolerance band, for most of 2018. The overall inflation pressures reflect accelerating wage growth amid robust growth of the domestic economy. Growth in domestic costs will record a further short-term increase owing to labour market tightness. Domestic inflation pressures will then moderate, aided by a stabilising effect of monetary policy. However, they will continue to outweigh the anti-inflationary effect of import prices, whose decrease will reflect a strengthening koruna and a temporary weakening of foreign producer price inflation. At the same time, the one-off factors that increased inflation at the start of this year will subside. Inflation will thus return to the 2% target from above over the monetary policy horizon.
The growth of the Czech economy will reach 4.5% this year. It will slow in the following two years. The increase in domestic economic activity will be driven mainly by robust growth in household consumption in an environment of high growth in household income. Investment will recover further, especially in the government sector as a result of higher drawdown of EU funds. To a lesser extent, fiscal policy will contribute to domestic demand growth in 2018 via a significant rise in public sector pay and increasing pensions and social benefits. The economy will continue to benefit from stable demand growth in the Czech Republic’s main trading partner countries. An increasing shortage of available labour force will cause employment growth to slow and wage growth to accelerate further. There is little room for unemployment to decrease further.
According to the forecast, the return of inflation to the target will be fostered by further growth in domestic market interest rates in addition to appreciation of the koruna. Roughly until mid-2018, growth in interest rates will be slowed by continuing quantitative easing by the European Central Bank. According to the forecast, the koruna will appreciate further against the euro, owing mainly to monetary policy being tightened sooner in the Czech Republic than in the euro area. The appreciation will also be fostered by continued real convergence. Starting with Inflation Report I/2018, the Czech National Bank will renew publication of the forecast-consistent path of the koruna-euro exchange rate, which was suspended temporarily in November 2013.
Compared to the previous forecast, the inflation outlook is slightly higher over the monetary policy horizon. The forecast for economic growth has also shifted higher for this year and to a lesser extent also for next year. The interest rate outlook for next year has been revised slightly upwards.
A majority of the Bank Board assessed the balance of risks to the current forecast at the monetary policy horizon as being slightly inflationary. A risk in this direction may arise from the exchange rate path. The exchange rate may appreciate at a slower rate than forecasted due to overboughtness of the koruna market. The strength, composition and inertia of fundamental inflation pressures from the domestic economy are also an inflationary risk to the forecast. The timing of further steps in raising interest rates will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna."
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