At its meeting today, the Czech National Bank's (CNB) Bank Board cut the two-week repo rate by a quarter percentage point to 4.25 %. It also cut other base rates by the same amount. Six board members voted in favour of the decision, while one member voted for a 0.5 percentage point rate cut.
The decision was based on the summer (August) macroeconomic forecast and an assessment of the information obtained since its preparation.
Inflation has been close to the 2% inflation target since the start of this year. Price stability thus persists in the country.
The CNB began to cut interest rates cautiously in December last year. But the fight against inflation is not over. The base repo rate gradually fell from 7 % to 4.25 %, easing the monetary policy restriction. In addition, there has been a noticeable decline in long-term rates abroad and at home in recent months, further easing monetary conditions. Nevertheless, the monetary policy stance remains tight. Real interest rates are positive, dampening credit activity and hence money creation in the economy, and consequently inflation.
The Board continued to see some inflationary pressures in the economy. An intensification of these would mean that inflation would detach more permanently from the target towards the upper boundary of the tolerance band in the quarters ahead. The Board therefore also considers it necessary to persist with a tight monetary policy and to consider further rate cuts carefully.
At its next meetings, the Board will base its assessment of the newly available data and their implications for the inflation outlook on the new data. The rate-setting considerations will depend mainly on an assessment of the persistence of the low-inflation environment, the exchange rate of the koruna, the effect of fiscal policy on the economy, an analysis of labour market tensions, developments in domestic and foreign demand and the actions of key foreign central banks. The Board will also assess the transmission of interest rate cuts to lending activity, asset prices and subsequently to real economic activity.
The Board notes that the rate-cutting process can be interrupted or stopped at any time at increasingly restrictive levels as interest rates approach neutral levels.
The Board reaffirms its commitment to continue tight monetary policy to keep inflation close to the 2% target in the long term.
Economic development
In line with our expectations, the Czech economy is recovering only slowly and remains below its potential. GDP grew by 0.3 % q-o-q and 0.6 % y-o-y in Q2. Growth was mainly driven by business fixed investment, while household consumption grew moderately (by 0.2 % q-o-q). It was still 5.2 % below the level recorded before the covide. With the decline in inflation, real household income growth is recovering. However, it is countered by negative sentiment developments. The recovery in domestic demand is thus slow, as confirmed by the retail and services sales figures. Foreign demand also remains subdued.
Labour market tensions are easing slightly, but unemployment remains low. Average wage growth reached 6.5 % in the second quarter, slowing from the first quarter. Historically, it remains elevated, but in real terms, wages are 5 % below their pre-quarter level. The risk of a wage-inflation spiral does not seem to be materialising.
Inflation has been close to the CNB's target since the start of this year. Headline inflation was slightly above the summer forecast in July and August, mainly due to faster growth in food prices. Core inflation was also higher than forecasted, confirming the correctness of the cautious approach to rate cuts.
A temporary increase in inflation towards the upper boundary of the tolerance band of the target could be expected at the end of this year owing to developments in the statistical base from the previous year. At the beginning of next year, inflation will fall and be close to the CNB's 2% target.
Risks and uncertainties
Overall, the Board assessed the risks and uncertainties to the outlook for meeting the inflation target as broadly balanced. The upside risk to inflation is increased wage demands in the private and public sectors. Any excessive growth in overall public sector spending would also lead to an inflationary risk for the government budget. Another upside risk to inflation is the higher-than-expected inertia of services price growth. Over the longer term, an upside risk to inflation is a possible acceleration of money creation in the economy stemming from a possible strong recovery in credit activity, especially in the property market. Conversely, a significant downside risk to inflation is the deterioration in global economic activity and the weaker performance of the German and hence the Czech economy. This is also reflected in the outlook for further rate cuts by the major central banks.
Legal mandate
The Bank Board assures the public that the CNB's actions will be sufficient to maintain price stability in line with the legal mandate. At the same time, the Board is prepared to respond adequately to any fulfilment of the risks to the forecast.
CNB/ gnews - RoZ
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