The rate hike by the Czech National Bank (CNB) was widely expected and accompanied by a new forecast that sees slightly lower inflation than previously expected but higher economic growth, resulting in a more gradual pace of market interest rate increases.
The CNB also resumed its policy of forecasting the exchange rate of the koruna - a policy that was frozen during the years it kept a lid on the koruna to boost inflation - and saw a stronger koruna in 2019 while market interest rates were lower than earlier expected.
The CNB raised its key rate by another 25 basis points to 0.75 percent and has now raised it by a total of 70 basis points since it began raising rates in August 2017 to curb above-target inflation from a booming economy that is driving up wages.
In addition to raising the two-week repo rate, the Lombard rate was raised by 50 basis points to 1.50 percent while the discount rate was maintained at 0.05 percent.
Inflation in the Czech Republic has remained above the CNB's 2.0 percent target throughout 2017 though it eased to 2.4 percent in December from 2.6 percent in November.
This year inflation is expected to continue to remain above 2.0 percent before returning to the target at the start of 2019 as strong inflation pressure from faster economic growth and wages eases.
The strong koruna will help keep import prices and thus inflation in check this year but higher administered prices keep inflation above the 2 percent level.
By the second quarter of 2019 inflation is expected to ease to 1.8 percent.
The Czech economy, which grew by 5.0 percent year-on-year, in the third quarter of 2017, will slow slightly in 2018 but growth will still exceed 3.0 percent, supported by external demand, robust consumption by households and strong domestic investment. A shortage of labour will continue to keep upward pressure on wages.
This year the Czech economy is seen growing by 3.6 percent, up from the previous forecast of 3.4 percent, but down from an estimated 4.5 percent in 2017. In 2019 growth is seen at 3.2 percent, up from 3.1 percent earlier forecast.
The forecast for the koruna-euro exchange rate sees a further rise in the Czech currency this year, mainly due to a widening of the interest rate differential to the euro as the European Central Bank (ECB) has yet to shift away from its asset purchases.
In 2019 the CNB sees the koruna firming to 24.5 to the euro from 24.9 this year, reflecting the assumption that the ECB will begin normalizing its monetary policy.
Today the koruna rose in response to the CNB's rate hike to 25.24 to the euro, up 1.9 percent this year and up almost 7 percent since April last year when the central bank ended its commitment to keeping the koruna below 27.
The Czech National Bank issued the following statement:
"At its meeting today, the CNB Bank Board unanimously increased the two-week repo rate by 25 basis points to 0.75%. At the same time, it increased the Lombard rate by 50 basis points to 1.50% 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 further rise in domestic market interest rates this year and especially next year. This, coupled with further appreciation of the koruna against the euro, will ensure that inflation returns to the target.
According to the external assumptions of the new forecast, the current robust growth in economic activity in the effective euro area will gradually slow to 2%. Growth in industrial producer prices will slacken temporarily at the start of this year. However, it will then recover again, owing among other factors to higher oil prices. Accommodative monetary policy of the European Central Bank will foster a return of euro area inflation to 2% in late 2019. 3M EURIBOR market rates will not turn positive until the end of next year. The expected outlook for the euro-dollar exchange rate is slightly below USD 1.20 to the euro. The Brent crude oil price will gradually decline from its current elevated levels almost to USD 60 a barrel at the end of next year.
Domestic inflation will remain above the 2% target this year. It will then return to the target at the start of next year. The currently strong inflation pressures, stemming from faster growth of the domestic economy and wages, will ease gradually. In 2018, this will be due mainly to a strengthening anti-inflationary effect of import prices, which will reflect appreciation of the koruna. At the same time, the one-off price factors that increased inflation last year will fully disappear. However, faster growth in administered prices will cause headline inflation to stay above the 2% target this year. Inflation will be just below the target over the monetary policy horizon.
The growth of the Czech economy will slow compared to last year, but it will exceed 3% nonetheless. The economy will continue to be supported by growth in external demand, robust consumption of Czech households and generally strong domestic investment activity. Rising labour demand coupled with an increasingly distinct shortage of available labour will manifest itself in continued rapid wage growth.
Starting with this forecast, the Czech National Bank is returning to the publication of numerical forecasts for the koruna-euro exchange rate. Like the interest rate forecast, the exchange rate outlook does not constitute any commitment by the Czech National Bank, nor can it be interpreted as the preferred or desired exchange rate level. Like the forecasts for all other variables, the exchange rate forecast is conditional on the assumptions of the forecast, including the outlooks for developments abroad. Unexpected shocks may cause the actual exchange rate to deviate in either direction from the forecast, sometimes significantly. However, its publication will give the market a useful guide to the future monetary policy stance, as it did before November 2013. A deviation of the actual exchange rate from the forecasted path may point to a need to change the outlook for the interest rate component of the monetary conditions.
According to the new forecast, the koruna will appreciate further against the euro. Its forecasted appreciation in the course of this year will mainly reflect a widening of the interest rate differential vis-à-vis the euro area and the impact of continued asset purchases by the European Central Bank. Ongoing real convergence of the Czech economy towards the euro area countries, associated with rising labour productivity, will act in the same direction over the entire forecast horizon. Next year, however, the koruna will firm only modestly to around CZK 24.5 to the euro. This will reflect, among other factors, the assumed shift of the European Central Bank’s monetary policy towards normal.
According to the forecast, the return of inflation very close to the target will be fostered by a rise in domestic market interest rates in addition to appreciation of the koruna. However, this rise will be slowed in 2018 by continued very accommodative European Central Bank monetary policy, which will add to the appreciation pressures on the koruna in the next few quarters. During 2019, domestic interest rates will converge smoothly to their assumed long-run neutral level, owing, among other things, to foreign rates turning positive again.
Compared to the previous forecast, the inflation outlook is slightly lower over the monetary policy horizon. By contrast, the forecasted growth of the Czech economy is slightly higher this year and the next. The pace of growth in interest rates is somewhat more gradual in 2019, while the koruna-euro exchange rate forecast for next year has moved to a rather stronger level.
The Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being balanced. At the same time, it stated that there are two bidirectional uncertainties of the forecast. The first one is associated with the strength of current and future domestic inflation pressures. The second, general, uncertainty concerns the exchange rate path."
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