Czech central bank ends cycle of increasing interest rates

Czech central bank ends cycle of increasing interest rates
The CNB is the first bank in Emerging Europe to halt the tightening cycle, according to UK-based forecaster Capital Economics.
By Albin Sybera August 5, 2022

The Czech National Bank (CNB) board kept its key interest rate at 7% – putting an end to a series of nine rises –when it met on August 4 for the first time following the changes in the board membership and the appointment of new Governor Ales Michl. 

The move makes the CNB the first bank in Emerging Europe to halt the tightening cycle, according to UK-based forecaster Capital Economics. Meanwhile, the US Fed and the ECB are just beginning their own tightening cycles.

"The interest rate is at a level that halts demand, slows down the growth of bank loans for enterprises and households, and halts the growth of money supply in the economy", Michl told a press conference. Many forecasters predict that the Czech economy will slip into recession around the turn of the year, as, like many countries, it struggles with stagflation.

While a board member, Michl always voted against rises in the interest rate, arguing that the causes of inflation were a temporary external cost-push, and could not be tackled by raising rates, which would just damage industry.

“Today’s decision to keep rates on hold demonstrates the stark contrast between the new board and the previous one, which had been the most hawkish central bank in the region over the last few years”, wrote Joseph Marlow, Assistant Emerging Europe Economist at  Capital Economics.  

The Czech crown initially fell on the news but later recovered to around 24.57 to the euro, up 0.5%, according to Reuters.

The CNB was, with Hungary's central bank, the first to raise interest rates in June last year, ahead of the current surge in inflation, and has continued to do so to try to change inflationary expectations. The June inflation level in Czechia of 17.2% is one of the highest in Europe, pushed by rises in energy and food prices. “We expect inflation to reach levels around 20% in the autumn”, said Michl. 

The CNB worsened its inflation outlook, as the inflation projection was upgraded from 13.1% to 16.5% in 2022, and from 4.1% to 9.5% in 2023.

The Czech economy is one of the few globally that has yet to return to its pre-pandemic size, said Capital Economics in a note last month. Persistent issues in the industrial sector have weighed on exports and investment has been sluggish.

Czech PMI figures released this week showed that rising inflation has dampened domestic and export demand, while putting up companies' input costs as they continue to grapple with supply chain problems.

The CNB forecasts a 4Q recession equal to 1.3% peak-to-trough,  but it expects overall GDP growth of 3.6% for this year, better than its previous forecast, and downgrades growth next year to 1.1%.

The CNB’s prognosis for the CZK currency is an average annual currency rate of CZK24.80 to the euro this year.  The bank said it would continue preventing excessive fluctuations of the crown, a policy that has helped the Czech crown to be the best performer in CEE so far this year, according to Reuters.  

Michl was appointed the governor of the CNB by President Milos Zeman – who also appoints the CNB’s board members – in May, effective of July 1, sparking an immediate sell off in the Czech crown. Michl has vowed to keep CNB a conservative institution under his watch.  

Many analysts pointed out Michl’s proximity to populist former premier Andrej Babis – Michl worked as Babis’ advisor and after Babis’ ANO made it to the Czech parliament for the first time in 2013 Michl was seen as ANO’s top choice for finance minister before Babis took the job himself.   Babis also openly welcomed the appointment of Michl as the CNB’s governor.