UPDATE

The Monetary Policy Council of the Czech National Bank (CNB) decided today to reduce the two-week repo rate (2T repo rate) by 0.25 percentage points to 4.0%. Simultaneously, it decided to reduce the discount rate by the same amount to 3.0% and the Lombard rate to 5.0%. Five members of the Monetary Policy Council voted in favor of this decision, one member voted to maintain current interest rates, and one member voted for a reduction of 0.50 percentage points. The newly established interest rates will be effective from November 8, 2024.

The decision was based on a new macroeconomic forecast, which implies a slight decrease in interest rates. The Monetary Policy Council also had two alternative scenarios available. The first scenario assumes a further slowdown in economic activity in the Eurozone, which translates into lower foreign demand and a faster decline in domestic inflation towards the target. The second scenario assumes higher profit margins for businesses than in the baseline scenario. This would lead to a higher persistence of inflation, especially in the services sector.

The CNB began cautiously reducing interest rates in December of last year. However, the fight against inflation is not over. The basic repo rate has gradually decreased from 7% to 4%, easing the restrictive monetary policy. Nevertheless, the monetary policy stance remains tight. Real interest rates are positive and dampen lending activity, and thus the creation of money in the economy, and subsequently, long-term inflation.

In the short term, the Monetary Policy Council expects a temporary increase in inflation due to the renewed rise in food prices. In addition, core inflation remains elevated, particularly in the services sector. Therefore, the Monetary Policy Council will approach any further easing of monetary policy very cautiously in the future, or may even pause the rate cuts.

At future meetings, the Monetary Policy Council will base its decisions on the evaluation of newly available data and their implications for the inflation outlook. Discussions about interest rate settings will be primarily influenced by the assessment of the persistence of the low-inflation environment, the development of the exchange rate of the Czech crown, the impact of fiscal policy on the economy, the analysis of labor market tensions, and the development of domestic and foreign demand. The Monetary Policy Council will also be prepared to react flexibly to the actions of key foreign central banks and geopolitical events, as well as to the potential realization of the scenarios mentioned above. The Monetary Policy Council will also evaluate the transmission of interest rate cuts to lending activity, asset prices, and subsequently, to real economic activity.

The Monetary Policy Council notes that the process of reducing interest rates may be interrupted or halted at still restrictive levels as interest rates approach neutral levels.

The Monetary Policy Council reaffirms its commitment to maintaining a tight monetary policy to ensure that inflation remains close to the two percent target in the long term.

https://twitter.com/CNB_cz/status/1854535549786132638

Economic Development

The Czech economy is recovering slowly and operating below its potential. According to preliminary estimates from the Czech Statistical Office (CSÚ), GDP grew by 0.3% quarter-on-quarter in the third quarter, and increased year-on-year to 1.3%. Domestic demand is supported by the growth of real household incomes and the easing of monetary policy restrictions. However, its recovery remains moderate and is dampened by increased savings. Foreign demand also remains subdued.

Tension in the labor market is easing slightly, but unemployment remains low. The average wage growth in the second quarter reached 6.5%, a slowdown compared to the first quarter. From a historical perspective, wage growth remains elevated.

Outlook

Overall, the forecast for this year projects an inflation rate of 2.5%, and it is expected to remain close to the inflation target next year, although it will be higher at the beginning of the year. This confirms the validity of the cautious approach to reducing interest rates that has been followed so far.

According to the forecast, the Czech Republic's GDP will grow by 1% this year, and economic growth is expected to reach 2.4% next year.

Risks and Uncertainties

The Bank Board has assessed the risks and uncertainties associated with achieving the inflation target as mildly pro-inflationary. A risk of higher inflation stems from the greater-than-expected persistence of price increases in the services sector. Excessive growth in overall public sector spending could lead to inflationary pressures from the state budget. Another pro-inflationary risk is the increased wage demands in both the private and public sectors. Over a longer time horizon, a possible acceleration in the creation of money in the economy, resulting from a significant rebound in lending activity, particularly in the real estate market, poses an inflationary risk. Conversely, a significant risk of lower inflation is a deterioration in global economic activity and weaker performance of the German and, consequently, the Czech economy. This is also reflected in the outlook for further interest rate cuts by major central banks.

Legal Mandate

The Bank Board assures the public that the Czech National Bank's actions will be sufficient to maintain price stability in accordance with its legal mandate. The Bank Board is also prepared to respond appropriately to any realization of the risks associated with achieving the inflation target.

Czech National Bank/ gnews - RoZ