CNB pauses its year-long rate-cutting cycle

At today’s meeting, the Czech National Bank, as expected, interrupted the year-long process of interest rate cuts. This was due to the bank board’s perception of a modestly inflationary balance of risks. According to Governor Michl, at the next meeting (in February), the CNB is likely to decide again between interest rate stability and further rate cut. The Governor continues to state that the board’s next steps will depend on newly released data. In our view, these should point to continued weakness in the Czech economy and a decline in inflation to close to the 2% target next year. We therefore expect further rate cuts at a pace of 25bp per meeting until June, when the repo rate should reach the 3% terminal level. However, given the hawkish bias of the board, the risk is that the easing could be more moderate than we expect.

The Czech National Bank left interest rates unchanged. The key repo rate remained at 4%. This was in line with our forecast, analyst consensus and financial market pricing. This intention was already reflected in recent statements by some of the bank’s board members, who continued to emphasise the upside risks to inflation. Five members of the Governing Council voted for rate stability. The remaining two voted for a 25bp cut. At the press conference it was said that the minority camp’s main concern was a possible sharper economic downturn abroad, especially in Germany, which would have an anti-inflationary effect on the Czech economy.

Of the pro-inflationary data, wages were the biggest surprise compared to the CNB’s November forecast. They rose by 7% yoy in 3Q, compared with the central bank’s forecast of 6.1%. Inflation itself was broadly in line with expectations. However, in our view, given the volatility of food prices in recent months and the increased dynamics of services prices, it cannot be ruled out that inflation could rise above 3% yoy in December, temporarily leaving the tolerance band of the inflation target. This risk may have supported keeping rates unchanged at today’s meeting in the eyes of the current Executive Board, which puts more emphasis on the observed data and the short-term outlook than on medium-term forecasts, even though economic growth and domestic demand remain relatively subdued in our view.

Ongoing economic weakness is likely to continue to put downward pressure on interest rates. Concerns about the magnitude of the traditional January revaluation probably also contributed to today’s decision to pause rate cuts. However, at its next meeting, the CNB should already have a flash estimate of January inflation, which the CZSO will start publishing next year. The publication of the preliminary January inflation data is scheduled for 6 February, as is the next monetary policy meeting of the central bank. In our view, inflation is likely to fall to close to 2.5% in January and average 1.8% for next year as a whole. Moreover, the recovery in the domestic economy is likely to be milder than the CNB’s forecast and we also expect the koruna to be stronger. We therefore expect the rate cutting cycle to resume next year at a pace of 25bp per meeting. The repo rate could thus reach the 3% terminal level in June. The lower potential growth of the Czech economy also points in this direction. Before the pandemic it was around 3%, but now we estimate it at 2-2.5%, also due to structural problems in the Czech economy. However, given the hawkish bias of the bank board, the risk is that monetary easing will be more moderate than we expect.

Author: Jaromír Gec