Czech Republic still holding out against deflation

By bne IntelliNews March 9, 2015

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Czech consumer price inflation (CPI) remained in positive territory at 0.1% in February, the statistics office reported on March 9, defying market expectations of a decline for another month. Yet despite signs that deflation pressure could now subside in the EU, the Czech central bank is thought unlikely to waver from its koruna cap.

The rise in CPI matched that seen the previous two months, as falling food and transport costs were offset by a rise in alcohol and utility and energy prices. The market had expected falling fuel prices to push the economy into its first deflation since 2009. Analysts polled by Bloomberg were looking for a drop of 0.1%.

While Visegrad peers have been mired deep in deflation for months, the Czechs have staved off price falls. Much of the credit for that must go to the Czech National Bank's cap on the koruna. It now appears the central bank's policy may have pulled the economy through, warding off imported deflation from the Eurozone and the oil price slump. There are signs those pressures are now subsiding.

EU core inflation estimates released on March 6 showed a broad-based rise in inflation, note Deutsche Bank analysts. "Assuming commodity prices remain stable, euro area inflation should now have bottomed," they suggest. "Oil-related energy prices — which had fallen every month since August — increased and first petrol price information for March suggests that prices will rise strongly again this month."

However, for the time being, oil prices continue to weigh on the consumer basket in the Czech Republic. Prices ticked higher on a monthly basis by 0.2% in February, mainly driven by a strong increase in alcohol and tobacco prices that helped neutralise downward pressure from fuel prices, which registered a 3.8% drop on the month. Over the past five months, fuel prices fell 18.2%, the statistics office said.

Still talking down the crown

As well as outperforming the market consensus, the inflation reading was 1bp above the CNB's own forecast for the month. That bolsters the bank’s stance that it will not further ease monetary policy for the moment. The market has speculated in recent weeks that it could try to weaken the koruna further to stave off deflation.

The CNB did however announce at its latest meeting in February that it will not exit the intervention policy before the second half of 2016. Previously, it had guided that the regime would run to at least the end of 2015.

The central bank has stuck to a policy of verbal - rather than actual - intervention since shortly after it launched the policy in late 2013. The koruna appreciated abruptly during February when President Milos Zeman criticised the weak crown policy. Yet a sharp rise in international reserves in February appears to indicate that the bank did not try to intervene to fight that.  "It turns out that CNB has not intervened at all," say analysts at Commerzbank.

However, the better-than-hoped February CPI data is unlikely to derail the verbal interventions, analysts at Capital Economics write. Despite the headline figure, core inflation slumped into negative territory for the first time since November 2013, edging down -0.1%, the analysts note. "It’s more likely than not" the CNB will move the exchange rate ceiling to a weaker level later this month, Capital Economics argues.

That would only deepen the rift between Zeman and the CNB board, appointed by the president's euro-sceptic predecessor Vaclav Klaus. Zeman claimed in March that the intervention policy is part of a plot to ward off adoption of the single currency. He announced he will seek to replace as many board members as possible with europhiles by the end of his term.

The next appointments to the Czech rate-setting board are due in July 2016, when the terms of Governor Miroslav Singer and board member Kamil Janacek expire. Two more posts open in 2017 for Zeman to fill before his term ends in 2018. Still, the majority of analysts do not expect the bank to ditch the cap before October 2016, according to a poll by Bloomberg.

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