Czech rate setters take the plunge

Czech rate setters take the plunge
By bne IntelliNews August 3, 2017

The Czech National Bank announced on August 3 that it will raise interest rates by 20bp to leave the benchmark at 0.25%, making it the first central bank in the EU to hike rates in the recovery business cycle.

The move has been the subject of no little debate in recent weeks, as the CNB is clearly concerned by the progress of core inflation above its 2% target. There are signs that further hikes could be in the pipeline for later this year or in early 2018, but at the same time the central bank struck a notably dovish tone at its press conference.

The hike in the benchmark is the first since February 2008, and breaks a run of close to five years during which rates have sat at virtually zero. The CNB board also decided to increase the Lombard rate by 25bp to 0.50% and keep the discount rate unchanged at 0.05%.

The move comes four months after the CNB dropped its cap on the koruna. Worries of a sharp rise in the value of the currency against the euro has clearly deterred a hike until now, but the koruna had made steady strides in recent weeks, reducing the risk of an erratic response.

Still, the CNB was clear in noting the pressures on monetary policy. The central bank asserted that inflation is “currently peaking” and argued that, despite strong wage pressure, growth in domestic costs will start to ease due to rising labour productivity growth.

A new inflation report is due to be released next week. The CNB said in its press release, however, that it expects core inflation to be fairly stable over the next 12-18 months, and that headline inflation will drop to its 2% target by early next year.

The CNB also noted it is eyeing a drop in imported inflation. Such issues have stayed the hand of policymakers in neighbouring Hungary and Poland, although interest rates in those countries have remained significantly above the Czech level. Another pressure point for the central bank is policy at the European Central Bank, which has pledged to keep its ultra-loose stance in place for some months.

As they were ahead of the August meeting, analysts are split on their forecasts for monetary policy in the coming months. At Capital Economics they predict a gradual cycle of rising interest rates to 0.75% by the end of 2018.

“We think inflation will be higher than most expect,” writes Liam Carson. “With the economy now operating at full employment, we expect wage growth to remain strong. The upshot is that, unlike the [CNB], we see core inflation rising a little further over the coming months. This will push headline inflation up towards the top end of the Bank’s 1-3% target range by end- 2017 and we expect it to remain above the 2% mid-point of the range next year too.”

At Komercni banka they still suggest another hike could be on the cards this year, although they note that the CNB guided for a pause of up to 12 months. "This is a long time to wait, given the CNB’s significantly improved outlook for GDP growth in 2017 and 2018," the analysts write.