Markets are absorbing a Czech central bank interest rates forecast that is not as hawkish as anticipated, following the October 2 decision to raise Czechia's main interest rate by 25 basis points to 0.50% in response to inflationary pressures being generated by Europe's fastest growing economy.

The increase was the second 25bp hike since August when the central bank became Europe's first monetary regulator to commence a tightening cycle. No other central bank in the EU has gone ahead with two rate hikes within this year. A third Czech increase may still be on the table for 2017, but the Czech National Bank (CNB) has made it clear that it is in no hurry to further bump up borrowing costs.

“The rate forecast is not as hawkish as the market expected,” ING economist Jakub Seidler told Reuters, adding that it showed only one rate increase next year. “The economy is doing well so definitely it is reasonable to expect more than one hike in 2018.”

“The prevailing view, and there was a unanimous vote in this respect, is that there is no reason for dramatic steps, and that we have enough time and room to raise rates in future meetings,” CNB governor Jiri Rusnok told a news briefing after the rates decision meeting. Some board members had indicated before the meeting that there would be more urgency shown towards tightening monetary policy. Rusnok said a sharper hike was debated but eventually the board opted 7-0 for a standard step, with the potential for another hike, perhaps in December.

The European Central Bank's decision last week to, from January, extend asset purchases, but at half the volume, until at least September next year will add cautiousness to Czech policy tightening by mid-2018, according to Rusnok's comments, because the ECB’s approach may preserve demand for the higher-yielding koruna for longer. That will essentially tighten the monetary conditions and consequently reduce the demand for rate hikes.

With Czech economic output growing by 4.7% y/y in the second quarter, wage settlements, amid the EU's lowest level of unemployment, are on the rise and the inflation rate is starting to feel the heat. Inflation rose by 0.2% to 2.7% y/y in September, although some analysts say it may have peaked at this level for this year.

A Reuters poll prior to the latest rate hike showed most analysts anticipate the CNB will introduce another rate hike for the first quarter of 2018 after a pause in December. But some central bankers had stated that they expected a firmer tightening because the Czech currency has not strengthened enough to hold back rate increases.

The koruna has gained by 5.6% to the euro since the central bank dropped its cap on the exchange rate in April. Just after the rates decision, it reached its highest level since the intervention was brought in in late 2013, edging up to CZK25.530/euro. But after the news conference it lost more than half a percent to CZK25.690/euro. At 1445 local time on October 3, it was at CZK25.653/euro. Under the cap, the koruna was prevented from strengthening beyond CZK27/euro.

The CNB board also voted at the monetary policy meeting to raise the Lombard rate by 50bp to 1.00% and keep the deposit rate at 0.05%. At its latest monetary meeting, the central bank only slightly changed its market interest rate view for the 3-month interbank Pribor rate to 0.9% for next year, just 0.2 percentage points up from its last forecast.

Foreign buyers, meanwhile, have continued to pile into Czech domestic government bonds—according to the finance ministry’s latest data issued on October 31, non-Czech holdings of such bonds moved up to a new high of 51.35% in September, almost double the 28.36% share seen a year ago and a substantial advance on August’s 46.12%.

A surge of foreign investors into the bonds was recorded prior to the central bank’s removal of the koruna cap.