Investments: the driver last year, the brake this year

Looking back at the last few issues of our Czech Economic Outlook quarterly we find headlines like ‘Households not about to lose their spending appetite’; ‘2016: Third year with no inflation’; and ‘Pay raises: later, but happening after all’. Although they were released a year ago, nothing fundamental has changed regarding these conclusions. Economic growth is so robust that the record employment rate continues to rise and the labour market is reaching its limits. The result is continuously increasing pressure on nominal wage growth, expected to reach 4% this year. The low inflation scenario is also turning out to be true, which also means strong growth in real wages.

We have already mentioned several times that the Czech economy’s growth in excess of 4% in 2015 was attributable to the coincidence of a number of non-recurring factors. Once this effect wanes, we expect the Czech economy will grow at approximately one half of last year’s growth rate. While investments were the driving force behind the economy last year, this year we expect them to act as a brake. Developments to-date have confirmed our concerns that last year’s boom in public investment co-financed with EU funds was significantly, but temporarily, underpinned by tapping the last of the EU money from the preceding programming period. Yes, we do have a new programming period and, as we noted in the February issue of the Czech Economic Outlook, the amount of available funds is not significantly smaller. However, the public sector is again facing a slow start to calls for proposals financed with money from the new programme. Still worse, complications have arisen because the environmental assessments (EIA) for some construction projects are too old to be eligible for EU financing. Unfortunately, this will have quite a major impact on the investment process in the public sector this year. The effect is already visible in the volume of public construction contracts being put up for tender. In short, civil engineering is facing a difficult 2016. In addition, the building sector is hampered by problems with regional development plans which frequently prevent projects, including those in Prague, from being launched.

But it is not only the Czech economy that is suffering from the rather sluggish start to 2016. Global financial markets had a chaotic start to the year and, on the macroeconomic side, the global economic picture was not very upbeat. Indeed, US central bankers have revised significantly downwards their expectations for dollar rate hikes. While the spring months show some signs of stabilisation, there is still one major risk ahead: Brexit. SG Economic’s team assign a 45% probability of the UK leaving the EU. The event would be so fundamental that it would generate global impacts. In the light of this, special boxes offer our views of what such a development could mean for the Czech economy and its financial markets. The globally low inflation environment—deferring dollar rate hikes and vindicating the ECB’s continued QE—has not stopped at the Czech national borders. Due to the revised inflation outlook we see an exit from the FX floor mode as happening no earlier than in Q3 17, providing the central bank actively intervenes in the forex market for at least another two quarters, limiting increased volatility in both directions. Because of the expected inflow of arbitrage capital, we expect negative rates for bank deposits over a set ceiling, specifically -0.5%, at the time of the exit.

Autor: Jan Vejmělek, Marek Dřímal, Viktor Zeisel, Jana Steckerová, David Kocourek