It is the first interest rate hike by the Czech National Bank (CNB) this year after a break following a hike in November 2018 and its 8th rate increase since August 2017 when it began tightening its monetary policy in the face of strong growth that was pushing up inflation.
But it is likely the last rate hike for a while as the CNB's latest forecast sees slowing inflation this year and stabilization around the 2.0 percent target in 2020 and lower economic growth due to a deterioration in the global economy against the backdrop of the risks of longer-lasting slowdown in the euro area and trade protectionism.
Governor Jiri Rusnok was later quoted as describing today's rate hike as a one-off and the outlook didn't see the need for raising rates further in the coming 12 months.
While the CNB's rate hike was widely expected due to an acceleration in inflation, it's hawkish stance is in stark contrasts with a more dovish monetary policy stance in most of the world, and especially in Europe where the European Central Bank pushed back any tightening until next year.
The CNB expects growth in the effective euro area, a measure based on those countries that import goods from the Czech Republic, to slow to 1.2 percent this year, down from its previous forecast of 1.5 percent, before rising to 1.6 percent next year, down from 1.7 percent.
The impact of slower demand for its exports means the economy in the Czech Republic is only expected to grow 2.5 percent this year, down from a previous forecast of 2.9 percent and 2018's growth of 3.0 percent that was sharply down from 4.3 percent in 2017.
After slowing during the second quarter of last year, economic activity in the Czech Republic picked up in the third and fourth quarters, with gross domestic product in the fourth quarter up 2.8 percent from 2.5 percent in the third quarter.
While inflation is forecast to remain in the upper half of the central bank's tolerance band this year due to price pressures and higher administered prices, the CNB said overall inflationary pressures are easing due to gradually falling wage growth, the fading impact of regulated price hikes and slower economic activity.
In March headline inflation accelerated to 3.0 percent from 2.7 percent the previous month but during the fourth quarter of this year inflation is expected to decelerated and by early 2020 it is expected to settle around 2.0 percent.
The CNB has a one percentage point tolerance range around its 2.0 percent target.
With Czech interest rates markedly higher than in the euro area, the CNB expects the koruna to firm this year to 25.3 on average against the euro but then ease to 24.7 in 2020 as the ECB returns to the path of monetary policy normalization.
During 5 years of extraordinary easy policy, the CNB not only lowered its key rate to a rock-bottom 0.05 percent but also intervened in foreign currency markets to keep the koruna low against the euro as an additional tool of easing.
As a first step toward tightening, the CNB in April 2017 scrapped its commitment to keeping the exchange rate of the koruna below 27 to the euro.
Since then the koruna has been largely steady against the euro though it slipped today following the CNB's less-than hawkish statement.
The koruna was trading at 25.70 to the euro today, down from 25.64 before the rate hike and little changed since the start of this year.
The Czech National Bank issued the following statement:"
"At its meeting today, the Bank Board of the Czech National Bank unanimously increased the two-week repo rate (2W repo rate) by 25 basis points to 2%. At the same time, it increased the Lombard rate to 3% and the discount rate to 1%.
The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast. Consistent with the forecast is a rise in domestic interest rates followed by broad interest rate stability until mid-2020.
According to the external assumptions of the new forecast, economic growth in the euro area will continue to slow until mid-2019 and then accelerate slightly again. Producer price inflation in the euro area will also slow further. Consumer price inflation in the euro area will rise slightly next year but will remain below 2%. The European Central Bank clarified that it will keep its interest rates at the current level at least until the end of this year. According to the market outlook, the 3M EURIBOR will thus remain negative until the end of 2020.
The price of crude oil rose during 2019 Q1 but is expected to fall slightly in the following period. The spread between three-month dollar and euro rates is expected to narrow gradually as a result of an expected decrease in the dollar rate. This should lead to a slight strengthening of the euro against the dollar.
Domestic inflation will stay in the upper half of the tolerance band around the target this year. This is due to persisting domestic inflation pressures, stronger administered price inflation and renewed growth in food prices. However, the inflation pressures are now easing overall. Besides a temporary fade-out of the inflationary effect of import prices, the domestic inflation pressures are also diminishing owing to gradually falling wage growth and slower growth in economic activity. Inflation will thus decrease to the 2% target at the start of next year. This will also be fostered by a further tightening of monetary policy and the fading out of the currently high growth in administered prices.
The Czech economy will grow by 2.5% this year and pick up slightly next year. The increase in economic activity will be driven by all components of domestic demand. Continued solid growth in household consumption will reflect high, albeit gradually slowing, growth in household income. Persisting labour shortages are still motivating domestic firms to invest. Government investment will also grow further, with projects co-financed from EU funds contributing significantly. Fiscal policy will also contribute to domestic demand growth this year via a rise in public sector pay, pensions and social benefits. The labour market is past its peak, but a tight labour market situation persists. Wage growth will therefore fall towards its steady-state level only gradually. The unemployment rate is at a record low, which is preventing it from decreasing further. In this context, total employment will rise more slowly as well.
A markedly positive interest rate differential vis-à-vis the euro area and continued real convergence of the Czech economy will cause the koruna to firm gradually this year. Next year, the exchange rate will appreciate more gradually owing to the start of monetary policy normalisation by the European Central Bank.
Consistent with the forecast is a rise in domestic interest rates followed by broad interest rate stability until mid-2020. The rise in rates at the start of the forecast is a reaction above all to the persisting domestic inflation pressures. The subsequent broad stability of rates until mid-2020 mainly reflects persisting negative interest rates in the euro area.
By comparison with the previous forecast, the inflation outlook for this year has been raised owing to stronger price growth at the start of the year. By contrast, the forecast for growth in domestic economic activity has been lowered, due mainly to a worse external demand outlook. The koruna will appreciate more gradually this year and the next on the basis of an assumption that the global factors that have led to its broad stability since 2018 Q2 will last somewhat longer. In connection with the slower appreciation, interest rates are higher over almost the entire forecast horizon.
The Bank Board assessed the risks to the inflation forecast as being broadly balanced. A more pronounced and potentially more protracted slowdown in economic growth in the euro area is a risk to the forecast. The impacts of protectionist measures in global trade remain a source of external uncertainty. Uncertainty is also associated with the exchange rate of the koruna going forward."
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