After four hikes in a row, we now expect the CNB to take a pause before the Christmas break. The MPC understands that the CZK is affected by temporary year-end effects and is willing to “see through” that. Recent softer data readings hinder medium-term inflationary pressures. Weaker GDP growth in 3Q18 has increased unit labour costs and contributed to supply pressures. Lower inflation was caused by volatile energy and food prices, while core inflation has surprisingly accelerated further. Looking ahead, a tight labour market should continue to support price growth. After a pause next week, we expect the CNB to continue with hikes in February, May and September, to reach 2.5%, the lower bound of its neutral rate estimates.

After four hikes in a row, we now expect the CNB to take a pause before the Christmas break. The MPC understands that the CZK is affected by temporary year-end effects and is willing to “see through” that. Recent softer data readings hinder medium-term inflationary pressures. Weaker GDP growth in 3Q18 has increased unit labour costs and contributed to supply pressures. Lower inflation was caused by volatile energy and food prices, while core inflation has surprisingly accelerated further. Looking ahead, a tight labour market should continue to support price growth. After a pause next week, we expect the CNB to continue with hikes in February, May and September, to reach 2.5%, the lower bound of its neutral rate estimates.

We expect the CNB to pause with hikes at its 20 December meeting. A pause would be consistent with the CNB forecast from early November. The central bank’s outlook implies 3m PRIBOR at 2.1% on average in 1Q19, consistent with flat rates in December and a hike in February. After that, the CNB expects a levelling-out of rates and relatively strong currency appreciation. We think the CZK will have a hard time keeping up with CNB expectations, and will disappoint again. Read more in our report here http://bit.ly/2Ehx4zb about why CZK is not appreciating and how elevated FX reserves affect monetary policy transmission.

Softer data readings mask inflationary pressures

Recent macroeconomic data releases support our view of a December pause before further hikes. GDP growth has stayed short of both our and the CNB’s expectations in 3Q, printing at 0.6% qoq. Although it was affected by weak foreign (predominantly German) demand, the sluggish growth reflects mainly domestic supply-side constraints. Unemployment remains at record lows, while wages are sprinting ahead at a pace exceeding 8%. With employment also on the rise, the disappointment in GDP implies higher unit labour costs and is leading to supply pressures on consumer prices. At the same time, the slowdown appears to be temporary, as the German car industry is surmounting the obstacles imposed by new emission limits. The first indicators for 4Q already show a solid pick-up in industrial production and retail sales, both domestically and abroad.

Softer inflation reading masks strong core inflation dynamics. While the headline inflation print for November of 2.0% missed the CNB’s forecast by 0.5pp, the core component has grown faster than the central bank expected. The low headline reading was caused by falling food prices, although this year’s weak harvest would indicate the opposite. Also, falling oil prices have started to affect fuels, although most of the pass-through is yet to come in December.

CNB likely to see risks as balanced

Overall, while the headline prints have been soft, they should reveal stronger underlying cost pressures through CNB optics. While the MPC does not get a full new forecast next week, it receives the so-called graph of risks to inflation projection (GRIP). This should show a roughly neutral balance of risks. The real economy and the exchange rate will likely appear on the pro-inflationary side, while the external environment and observed inflation would bring the balance back to neutral.

Also, public appearances by MPC members suggest that the CNB may take a break from hikes in December and continue next year. Governor Rusnok said that he is “increasingly tilting toward the view that there is no rush” and “slightly in favour of waiting until next year”, citing the CZK year-end effect as one of the reasons. Still, he acknowledged the overheated job market and expects “durable and robust” wage pressures. On a more hawkish note, MPC member Benda said that, despite the “whisker lower” inflation, the pressures remain strong and that the “exchange rate pushes it slightly towards higher rates already in December”. New MPC members Michl and Holub have kept a low profile, and we do not expect them to deviate from the majority. Also, freshly appointed vice governors Mora and Nidetzky are likely to vote with the governor, in our view. Dovish Dedek would be happy to raise a hand in favour of no hike. The only dissenter might be Benda.

CNB to take a breath in December, but continue with three hikes in 2019 

December CNB meetings are usually uneventful, and we expect it to be the case this year as well. Still, the communication should suggest readiness to continue with monetary policy tightening next year if CZK does not rapidly strengthen. If the communication fails to deliver this message, the market could be disappointed. That said, the current market pricing of just one hike next year seems overly cautious to us. Based on recent data, our macro outlook and talk from MPC members, we expect three hikes in 2019, in February, May and September. This would bring the main policy rate towards 2.5%, the lower bound of the range of neutral rate estimates.

Overall, VIG reported slightly better-than-expected results for 3Q18. The biggest difference against the consensus was the financial result, which was pushed up by income from disposal of investments. The combined ratio drop was positively affected by lower insurance claims thanks to minimal natural disasters. Management confirmed its guidance for this year’s GWP and earnings before taxes.

Overall, VIG reported slightly better-than-expected results for 3Q18. The biggest difference against the consensus was the financial result, which was pushed up by income from disposal of investments. The combined ratio drop was positively affected by lower insurance claims thanks to minimal natural disasters. Management confirmed its guidance for this year’s GWP and earnings before taxes.

Facts and figures: (1) Gross premiums written rose 1.2% yoy and reached EUR2.21bn in 3Q18. Property and casualty insurance (+4.4%) and health insurance (+5.5%) slightly exceeded our expectations; on the other hand, life insurance (-3.6%) dropped more significantly. (2) 3Q18 revealed a decline in GWP in Austria (-1.9%) and Poland (-7.2%) due to a drop in life single-premium business, which is in line with current trends and company’s strategy. Slovakia’s premium was flat, and GWP in the Czech Republic rose 2.2%. A drop was registered also in Turkey/Georgia (-19.7%), which was driven by FX effects. (3) The financial result came as the biggest surprise, recording an increase of 16.8% in 3Q18 as a result of realised gains from disposal of investments. (4) VIG booked significantly higher other expenses (+74%) related to precautionary measures in Poland and Romania. These are connected with provisions regarding surrender fees for unit- and index-linked life insurance products in Poland and reserve strengthening in motor business and a provision for a current market-wide investigation of the Romanian Competition Council in Romania. (5) For the first three quarters, VIG reported a combined ratio of 96.3%, dropping from 97.3% a year ago. The claims ratio went down 1.5pp, while the cost ratio increased 0.5pp. (6) EBT went up 8.0% to EUR119.6m in 3Q18. All of the segments contributed positively, with the exception of Romania.

Management’s mid-term guidance: VIG confirmed a minimum GWP volume of EUR9.5bn in 2018 and profit before taxes within a range of EUR450-470m this year. For 2020, the company estimates GWP of more than EUR10bn and profit before taxes within a range of EUR500-520m. The combined ratio is targeted at around 95% by 2020.

Potential impact on share price/recommendation: 3Q18 figures confirmed current trends, and we expect VIG is on track to reach its target for this year. Moreover, the insurance company is gradually fulfilling the goals set in Agenda 2020, which should bring additional income or cost savings in the future. Economic growth remains strong in the CEE region and should continue to support the company’s performance. We keep our Buy recommendation.  

Main risks: Natural disasters and insurance frauds are the main risks. Weaker economic trends and a longer period of a low interest rate environment would negatively influence VIG’s performance.

Upcoming events: The conference call with VIG’s management starts today at 3 p.m. CET. The insurance company will announce its 2018 preliminary results on 21 March 2019.