Inflation to have hit zero in June

Figures for May to be published this week in the Czech Republic are set to point to a strong economy, with retail sales and imports likely posting solid growth. However, Inflation is set to slow to zero for the first time in two years on the back of a drop in food prices. While such a reading would be in line with the central bank’s own forecast, negative market reaction cannot be ruled out.

May’s industrial production should be driven by the automotive sector, where output surged massively over the month. This was partly due to calendar factors (three extra working days versus May 2015) that should boost other sectors too. In month-on-month terms, however, we expect a minor correction (-0.6%, SWDA), with the shutdown of a major refinery likely playing a part in this.

Construction, on the other hand, is set to improve after its sharp drop of previous months. We look for a 1.2% mom increase in construction activity, which should slow the year-on-year drop in the sector to -10.5% (construction has been hit mainly by a lack of infrastructural investment).  

May’s retail sales growth (ex cars) is set to print at 7.7% yoy on the back of positive calendar effects and strong consumer spending. Rising wages, declining unemployment, solid confidence and generous fiscal policy have all stimulated household consumption over the past few months.

The external trade balance should post a surplus of CZK14.8bn for May after the strong April reading of CZK23.6bn. We attribute the deterioration to a growing deficit in the commodity balance (rising oil prices) and an acceleration of imports due to calendar effects and strong domestic demand (household consumption). May’s data notwithstanding, we expect external trade to reach the highest surplus in history in the full year of 2016. 

Due to the sharp improvement during the past two years, the labour market has started to reach its limits. Moreover, the slowing economy and risks for future developments have been curbing demand for new workers. We expect the seasonally-adjusted share of the unemployed to have subtracted just 0.02pp in June to 5.65% – still a new post-2009 low. Positive seasonal factors likely slashed the headline reading to 5.3% (NSA) from May’s 5.4%.

Drop in food prices to drag inflation to just zero

While figures from the real economy should deliver favourable news, inflation is another story. We estimate prices stalled in June both on a month-on-month and year-on-year basis. While fuel prices increased sharply on the back of rising oil prices and solid demand likely allowed prices to grow in the core index, there was a sizeable drop in food prices as seen per weekly surveys. As a result, inflation is set to slow to zero for the first time in two years.

Note that the CNB staff forecast is also pointing to the same reading. However, the psychological effect on the market cannot be ignored – and it is likely that the Czech currency will weaken in response to this divergence of inflation from the CNB’s target. The central bankers are likely to communicate the possibility of shifting the EUR/CZK FX floor to weaker koruna levels in the weeks to come – but we assume this scenario is a possibility only if deflationary pressures emerge. In our baseline scenario, we call for acceleration of inflation in H2 16 – mainly on the back of a low statistical base in 2015.    

Autor: Marek Dřímal