Weak economy should prompt further CNB rate cuts

At yesterday’s meeting, the Czech National Bank cut interest rates again at a cautious pace of 25bp, in line with expectations. In its newly published forecast, the CNB expects growth in the Czech economy to accelerate significantly from 4Q24 and inflation to remain above the 2% target until 2026. Nevertheless, the CNB expects the repo rate to reach its neutral level of 3% in 2Q25. We expect the same, but with a lower GDP and inflation outlook. Specifically, we expect a 25bp cut in the repo rate at each of the CNB’s monetary policy meetings until May 2025. The bank’s board has continued to stress that the next steps will depend on newly released data. In our view, the data should point to ongoing weakness in the economy, which should be the main reason for further monetary easing.

The Czech National Bank cut interest rates by a further 25bp yesterday, continuing its gradual easing of monetary policy. The key repo rate fell to 4%. This was in line with our forecast and the analyst consensus, and also broadly in line with financial market pricing. Five of the seven board members voted for a 25bp cut. Of the remaining two, one voted for rate stability and the other for a more substantial cut of 50bp. Tomáš Holub, who will leave the board at the end of November, is likely to have supported a 50bp cut, as he did at the September meeting.

According to its latest forecast, the CNB continues to expect a rapid economic recovery, which we think is unlikely. For 3Q24, the central bank has estimated growth at 0.3% qoq, in line with the preliminary GDP estimate. However, it forecasts the growth rate to accelerate significantly to 0.7% qoq from 4Q24 and to remain around this level until the end of next year. As a result, the central bank expects the Czech economy to grow by 1.0% this year and to accelerate strongly to 2.4% next year. We are more pessimistic, forecasting growth of 0.8% in 2024 and 1.5% in 2025. The monthly indicators, including retail sales and services, industrial production and also economic sentiment, do not point to a strong economic acceleration in 4Q24. Moreover, 4Q24 is likely to be negatively affected by the impact of the September floods. The CNB forecast implies annualised GDP growth of 2.8% in 4Q24, which in our view would even exceed the estimated potential output growth. If the Czech economy does indeed grow by 2.4% next year, it would more likely be a leader rather than a laggard in Europe. Given the structural problems the economy is currently facing and the subdued outlook for the German economy, which by most estimates is unlikely to grow by more than 1% next year, the CNB forecast for Czech GDP seems too optimistic.

The central bank expects inflation to remain above the 2% target throughout the forecast horizon, but the repo rate should reach its terminal level of 3% in 2Q25. After 2.5% in 2024, the CNB even forecasts inflation to accelerate slightly to 2.6%. Our inflation forecast is the same for this year, but significantly lower for next year (1.8%). This may reflect the different views on the economy mentioned above. Indeed, we see continued weak demand, also as a result of tight monetary policy, as one of the reasons for our expected decline in inflation in 2025. Lower energy and fuel prices should be another. Despite the different views on the economy and inflation, our interest rate forecast is not fundamentally different to the CNB’s. One interesting aspect of the CNB forecast is that it puts inflation above the 2% target over the monetary policy horizon (currently the turn of 2025 and 2026). According to the CNB’s new forecast, inflation should be 2.4% yoy in 4Q25, then fall to 2.2% yoy in 1Q26 and average at 2.2% for the whole of 2026.

We expect the CNB to continue to cut interest rates by 25bp at each monetary policy meeting until May next year, when the repo rate should reach its terminal level of 3%. The main reason for the continued rate cuts should be the weak economy. Despite strong GDP growth and persistently high inflation in the CNB staff forecast, the board continues to see the risks as tilted towards potentially higher inflation. According to Governor Michl, the central bank may therefore stop cutting rates at some future meeting. He also said that the possibility of interest rate stability was discussed yesterday. As a result, we see the risks to our CNB rate forecast as skewed to the upside.

Author: Martin Gürtler