Thursday, August 3, 2017

Czech raises rate 20 bps, further hikes based on koruna

    The central bank of the Czech Republic raised its benchmark two-week repurchase rate by 20 basis points to 0.25 percent, a move that was expected by many economists, and said "the timing of further steps in raising interest rates will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna."
     The rate hike follows the Czech National Bank's (CNB) first step toward normalizing its monetary policy stance in April this year when it abandoned its commitment from November 2013 to keep the exchange rate of the koruna from rising above 27 to the euro as an additional tool to prevent deflation.
    "Inflation pressures are currently peaking, reflecting accelerating growth in wages and economic activity," the CNB said as it raised its forecast for economic growth due to faster-than-expected household consumption and investment.
     In addition to raising its two-week repo rate, the CNB raised its Lombard rate by 25 basis points to 0.50 percent while the discount rate was unchanged at 0.05 percent. 
     It is the first rate hike by the CNB since February 2008 when the rate was raised to 3.75 percent, only months before the global financial crises erupted in full force.
     In the wake of the global financial crises, economic slowdown and the threat of deflation, the CNB slashed its rate 11 times, culminating in November 2012 when the rate was cut to 0.05 percent.
    With its key interest rate essentially at zero, CNB in November 2013 decided to use the exchange rate as an additional monetary policy tool to keep the koruna from rising above 27 to the euro.
     The Czech koruna immediately jumped on news of today's rate hike to 25.9 to the euro before easing slightly to around 26.0, up 3.8 percent since the exchange rate cap was lifted.
     Underpinning the rate hike is the central bank's updated forecast that sees the Czech economy expanding by 3.6 percent this year, up from its previous forecast of 2.9 percent as consumers turn optimistic amid growing employment, accelerating wages and low interest rates.
     At the same time, the CNB expects investment to recover, especially by the government, while the economy benefits from growth in the country's main trading partners.
      "However, its favorable effect on net exports will be gradually outweighed by rising domestic demand and a stronger exchange rate," the CNB said. 
      The koruna is seen rising due to the interest rate differential to the euro area, where the European Central Bank (ECB) is continuing with quantitative easing, and growth in the Czech Republic.
      Next year the CNB expects the Czech economy to grow 3.2 percent, up from 2.8 percent previously forecast, and then by 3.1 percent in 2019.
     In the first quarter of this year Gross Domestic Product in the Czech Republic grew by an annual rate of 3.0 percent, up from 1.9 percent in the previous quarter.
     Inflation has been over the central bank's 2 percent target in the last seven months though it eased to 2.3 percent in June from 2.4 percent in May and the CNB expects growth in costs to ease as labour productivity improves and the koruna's exchange rate rises, holding down inflation.
     For the third quarter of 2018 the CNB lowered its inflation forecast to 1.9 percent from a previous 2.0 percent and for the fourth quarter of 2018 inflation is seen averaging 1.8 percent, down from 1.9 percent. Upside risk to the forecast stemming form a weaker-than-forecast exchange rate as financial investors close their koruna positions.


     The Czech National Bank issued the following statement:


"At its meeting today, the Bank Board of the Czech National Bank decided unanimously to increase the two-week repo rate by 20 basis points to 0.25% The Lombard rate was increased by 25 basis points to 0.50%. The discount rate was left unchanged at 0.05%.
The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast of the Czech National Bank. Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3. According to the forecast, inflation will stay in the upper half of the tolerance band for the rest of this year and decrease towards the 2% target at the start of next year.
According to the assumptions of the new forecast, economic growth in the effective euro area will fluctuate around 2% over the entire forecast horizon. It will be highest in the second half of this year. Growth in industrial producer prices will slow this year and early next year. This will be due mainly to the fading effect of the previous rise in prices of energy and industrial commodities. Producer price inflation in the euro area will then rise again. Consumer price inflation in effective terms will increase slightly. The outlook for 3M EURIBOR market rates is negative until early 2019 on account of the European Central Bank’s still easy monetary policy.
The euro-dollar exchange rate is expected to remain relatively stable. The Brent crude oil price will be close to the current levels, i.e. around USD 50 a barrel, over the entire forecast horizon.
According to the new forecast, domestic inflation will stay in the upper half of the tolerance band around the 2% target this year. Inflation pressures are currently peaking, reflecting accelerating growth in wages and economic activity. Growth in domestic costs will slow in the period ahead due to rising labour productivity growth, which will increasingly offset the impact of faster growth in wages and economic activity. The current already only slightly inflationary effect of import prices will quickly turn anti-inflationary. This will reflect subdued foreign producer price inflation and a strengthening koruna. Inflation will thus decrease towards the Czech National Bank’s 2% target in early 2018 and will be slightly below it over the monetary policy horizon. Core inflation will meanwhile fluctuate stably around 2%.
The growth of the Czech economy will accelerate visibly above 3% this year. It will stay slightly above this level in the following two years. Growth in domestic economic activity will be driven by robust growth in household consumption. This will continue to reflect optimism of consumers in an environment of ongoing employment growth, accelerating wages and low interest rates. At the same time, investment will recover, especially in the government sector as a result of higher drawdown of EU funds. The economy will also benefit from continued demand growth in the Czech Republic’s main trading partner countries. However, its favourable effect on net exports will be gradually outweighed by rising domestic demand and a stronger exchange rate. Stable growth in labour demand coupled with an increasingly distinct shortage of available labour will manifest itself in robust wage growth.
Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3 and later also in the following two years. However, the return of interest rates to their long-run neutral level will be strongly hampered until around mid-2018 by the European Central Bank’s ongoing quantitative easing. According to the forecast, the koruna will appreciate further against the euro. The appreciation will be due to continued real convergence of the Czech economy to the euro area, a positive interest rate differential vis-à-vis the euro area and ongoing asset purchases by the European Central Bank. However, the exchange rate forecast does not take into account that the appreciation of the koruna may still be strongly dampened in the coming quarters by market “overboughtness”. This is due to exchange rate risk hedging by exporters before the exit from the exchange rate commitment and the large koruna positions of financial investors.
Compared to the previous forecast, the outlook for inflation and market interest rates is almost unchanged. However, the GDP growth forecast has shifted higher, due largely to faster expected household consumption growth and investment growth.
The CNB Bank Board assessed the risks to the new inflation forecast at the monetary policy horizon as being slightly inflationary. This is because the exchange rate may be weaker than forecasted in the quarters ahead owing to the closing of koruna positions by financial investors amid the absence of a counterparty. The timing of further steps in raising interest rates will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna."




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