The Czech National Bank (CNB) has increased its two-week repo rate by 25 basis points to 0.75%, underpinned by a new macroeconomic forecast.

At the same time, it increased the Lombard rate by 50 basis points to 1.75% and kept the discount rate unchanged at 0.05%. 

The increase is the first since the central bank began a tightening cycle in June on fears of rising inflation.

"An interest rate hike at the August meeting was recommended by the CNB's May forecast and in recent weeks the majority of the board members, including Governor Jiří Rusnok, said they supported an increase in interest rates," said Radomir Jac, Chief Economist at Generali Investments CEE, for the Czech News Agency. 

He expects interest rate hikes to continue also in September and November. "The gradual tightening of monetary conditions through higher interest rates will help dampen inflation and related imbalances, which may help the economy maintain solid growth in the medium term," he added.

According to Jakub Seidler, Chief Economist at the Czech Banking Association, the CNB decision has already been reflected in market interest rates, including mortgage rates. "Therefore, today's CNB rate hike will not in itself lead to a jump in mortgage rates," he noted.

“The CNB caused little surprise with its 25bp rate hike earlier today, as the board members have been signalling the move for weeks. The bank remains characteristically hawkish, with appetite for further hikes clear among some board members,”  analysts from Oxford Economics said, adding that CNB might be tempted to add another hike before the end of 2021, but given the risk to growth in the winter months, they think caution should now take over.

The central bank has also increased its forecast for  Czech economic growth to 3.5% (up from 1.2% estimate from May) in 2021 and 4.1% (down from 4.3%) in 2022. For 2023,  Czech GDP is expected to return to a  growth rate of 3%.

“Renewed economic growth will be driven by strongly recovering household consumption, aided, among other things, by the release of part of the forced savings created during lockdowns. Consumer sentiment will also be boosted by a gradual improvement in the labour market situation. The overloading of global supply chains, which is currently hindering the production and export performance of Czech industry, will weaken over the rest of this year,” the CNB said in its statement. 

The inflation is expected to rise above the upper boundary of the tolerance band around the 2% target this year, mainly as a result of an increase in food prices inflation and strong fuel price inflation. Next year the inflation should return towards the 2% target. 

“We argue that the underlying inflationary forces will remain subdued. Q2 GDP growth disappointed, with the flash estimate only at 0.6% q/q. And while high-frequency data show activity continues on an uptrend and the unemployment rate fell to 3.8% in June, we expect the negative output gap and labour market slack to dampen inflation,”  Oxford Economics noted.

A 3.5% economic growth for this year is also foreseen in the latest forecast of the Czech Chamber of Commerce. For the next year the chamber is more optimistic than the CNB, expecting the economy to increase by 4.6%. Despite a shortage of chips and raw materials, Czech industry will remain strong this year, however, household consumption will be more cautious.

Inflation is forecast to fall from 3.4% this year to 2.4%. The chamber expects unemployment to reach 3.3%. The average nominal wage should increase by 3.4% this year, followed by 4.8% growth in 2022.