The Czech National Bank (CNB) raised its 2-week repo rate by another 25 basis points to 1.25 percent, it's third rate hike this year, and has now raised it by 1.20 percentage points since August 2017 when it embarked on a monetary tightening cycle in response to rising inflation from higher wages amid strong economic growth.
The central bank said it had raised rates earlier than previously forecast because the exchange rate of the koruna had been weaker than expected due to global factors - a reference to the rise in the U.S. dollar on strong U.S. growth - along with higher inflation.
"The overall fundamental inflation pressures remain strong and will rise even further in the short run," CNB said, attributing this to buoyant wage growth, higher fuel, food and regulated electricity prices at the same time of a temporary halt to the earlier anti-inflationary effect on import prices.
The CNB raised its forecast for inflation to average 2.1 percent in the third quarter of 2019, up from an earlier forecast of 1.8 percent, and fourth quarter inflation to 2.0 percent from 1.9 percent.
Inflation in the Czech Republic jumped to 2.6 percent in June from 2.2 percent in May, well above the CNB's 2.0 percent target.
During 2020 inflation is expected to remain close to the bank's target as inflationary pressures wane on high interest rates, slower wage growth and renewed appreciation of the koruna.
The koruna is forecast to average 25.5 to the euro this year, down from an earlier forecast of 25.0, but then firm in 2019 to average 24.6 to the euro and then to 24.2 in 2020.
The koruna depreciated against the euro between April and early July but has recently bounced back. It then fell following the rate hike to trade at 25.64 to the euro, down 0.4 percent this year.
The Czech economy is expected to slow this year after last year's high pace but still grow 3.2 percent and then 3.4 percent in 2019 and 3.3 percent in 2020.
In the first quarter of this year the economy grew by an annual 4.4 percent, down from 5.5 percent in the last quarter of 2017.
The Czech National Bank issued the following statement:
"At its meeting today, the Bank Board of the Czech National Bank unanimously increased the two-week repo rate by 25 basis points to 1.25%. At the same time, it increased the Lombard rate by 25 basis points to 2.25% and the discount rate by 20 basis points to 0.25%.
The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast of the Czech National Bank. Consistent with the forecast is a continued rise in interest rates towards their long-run neutral level. Room for an earlier increase in interest rates than assumed by the previous forecast has been created mainly by a deviation in the path of the koruna exchange rate due to global factors. More inflationary factors in the domestic economy have also contributed.
According to the external assumptions of the forecast, economic growth in the euro area is expected to slow gradually. A weakening of the euro and higher energy prices have moved the outlook for both producer and consumer prices in the euro area upwards for this year. Inflation will thus be just below 2% over the next two years. This will enable the European Central Bank to end its asset purchase programme at the end of this year. However, the European Central Bank has stated that will not start increasing interest rates until some time later. The 3M EURIBOR is thus expected to remain negative until early 2020. The price of Brent crude oil will decline gradually from its current elevated level. The market expects the euro to appreciate slightly against the dollar from its current weakened level.
The increase in domestic inflation above the 2% target during Q2 reflected, among other factors, growth in volatile consumer basket items – fuel and food prices. Administered prices of electricity increased as well. The overall fundamental inflation pressures remain strong and will rise even further in the short run. They are connected mainly with buoyant wage growth in the Czech economy. At the same time, the anti-inflationary effect of import prices will halt temporarily. Import prices reflect the koruna’s recent depreciation stemming from a deterioration in sentiment on global markets. Until mid-2019, therefore, the koruna will be above the 2% target, although still within its tolerance band. In the meantime, the overall inflation pressures will start to ease gradually owing to continued growth in interest rates, renewed appreciation of the koruna and slower wage growth. Inflation will thus return to the Czech National Bank’s 2% target at the monetary policy horizon, i.e. in the second half of next year. During 2020, it will stay close to the target.
The growth of the Czech economy will slow from last year’s high pace this year. However, it will remain above 3% in the following years. It will be driven mainly by robust growth in household consumption, reflecting optimism of consumers in an environment of rapid growth in their income. Briskly rising external demand and increasingly distinct labour shortages will continue to motivate domestic firms to invest in machinery and equipment. Fiscal policy will contribute to domestic demand growth in 2018 and 2019 via faster drawdown of EU funds and a significant rise in current expenditure. By contrast, the monetary conditions will tighten further in the interest rate component and later also in the exchange rate component again. The contribution of net exports to economic growth will be temporarily negative this year. The strong economic growth is reflected in a very tight labour market. The unemployment rate is at a record low and there is little room for it to decrease further. Employment growth will therefore slow, while wage growth will remain high. However, it, too, will moderate gradually in the following years.
After weakening temporarily, the koruna will return to an appreciation trend. The exchange rate forecast reflects a recent change in sentiment on foreign exchange markets and a related outflow of short-term capital from emerging markets. This global effect is expected to partly persist in the next two quarters. Nonetheless, the koruna will start to appreciate again at the close of this year. This appreciation will be driven by a distinctly positive interest rate differential vis-à-vis the euro area, the fading effects of asset purchases by the European Central Bank and real convergence of the Czech economy According to the forecast, the koruna will thus appreciate below CZK 25 to the euro in early 2019.
Consistent with the forecast is a continued rise in interest rates towards their long-run neutral level. This is a reaction to marked inflation pressures from the domestic economy and, in the second half of this year, also to the temporary depreciation of the koruna. The broad stability of rates next year is a result of renewed appreciation of the koruna amid continuing very easy monetary policy of the European Central Bank. A subsequent tightening of its policy combined with a broadly stable koruna exchange rate will create room for further growth in domestic rates in 2020.
Compared to the previous forecast, the inflation forecast is higher for the coming year, although only slightly at the monetary policy horizon. By contrast, the forecast for the growth of the Czech economy this year is markedly lower, while the outlook for next year remains unchanged. The shift of the exchange rate outlook towards weaker levels takes into account past market developments driven by the worsening of global sentiment. Together with other factors, this leads to a need for higher interest rates this year. The longer outlook for domestic rates is little changed.
The Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being balanced. The main uncertainty is the duration of the global factors which recently caused the koruna to depreciate. Growth in protectionist measures in global trade and an escalation of the USA’s trade disputes with the euro area and other trading partner countries are an additional source of external uncertainty. The inflation outlook for the coming months in the area of food and fuel prices represents a short-term downside risk."
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