Inflation will be tamed over the next year and a half
At its August meeting, the Bank Board kept the two-week repo rate at 7%. The decision is based on the baseline scenario of the CNB’s summer macroeconomic forecast. In that forecast, the central bank – due to extraordinary cost pressures amid greatly increased uncertainty – currently looks at a monetary policy horizon two quarters further ahead than the one used previously in the CNB’s forecasting system. Inflation will rise slightly above 20% in the months ahead and remain in double figures for part of next year. This will reflect continued growth in gas and electricity prices for households, a further acceleration in food price inflation and persisting high core inflation. Inflation will decline rapidly below 10% in the course of 2023 owing to an easing of the current exceptional price pressures and to the previous tightening of domestic monetary conditions. During 2024, inflation will fall close to the CNB’s 2% target. Consistent with the forecast, in which the central bank sets interest rates in order to achieve the 2% target at a monetary policy horizon 18–24 months ahead, is broad stability of market interest rates initially, followed by their gradual decline next year. The Bank Board assessed the risks and uncertainties of the baseline scenario of the summer macroeconomic forecast as being significant and going in both directions. The escalating inflation pressures are largely due to strong external price shocks lying outside the control of domestic monetary policy. In line with the baseline scenario of the forecast, the Bank Board decided currently to disregard the direct effects of these external price pressures on inflation and not to increase interest rates for the time being.
The Czech economy is facing a combination of exceptionally strong inflation pressures causing escalating broad-based price growth. Inflation in the domestic economy continues to hit new long-term highs in rapid succession. Consumer prices are being pushed up by rising costs, reflecting domestic and foreign factors, including higher energy prices, and growth in the margins of domestic producers, retailers and service providers amid a still solid income situation of households.
The surging consumer price inflation was driven in spring and early summer by still rising core inflation. However, prices of food and housing-related energy also rose increasingly quickly. In addition, year-on-year growth in fuel prices stayed exceptionally high. Core inflation will pick up slightly further in the months ahead, reflecting firms’ peaking profit margins and growth in costs, including energy prices. The contribution of the still rapidly rising cost of owner-occupied housing (imputed rent) to inflation will remain significant. Growth in food prices will increase further, on the back of rising global prices of agricultural and food commodities. Year-on-year growth in fuel prices will initially remain very high as well, but prices at filling stations will start to fall due to lower oil prices. Further growth in excise duty on tobacco will foster higher headline inflation this year and the next. A waiver of the fee for renewable energy sources within administered prices of electricity will have the opposite effect.
As a result of the above factors, inflation will peak at just over 20% in late summer and early autumn 2022. It will then start to fall as growth in production costs slackens, the purchasing power of households drops and the stabilising effect of monetary policy manifests itself through domestic demand. The downward trend in inflation will gain strength in the course of next year. Inflation will decline close to the CNB’s 2% target over the monetary policy horizon, which for this forecast lies in the first half of 2024.
Czech firms continue to face rapid growth in costs, driven largely by import prices. Besides rising foreign industrial producer prices, the growth in import prices is dominated by skyrocketing energy prices. The strong inflationary effect of import prices is now peaking. Their growth will fade, aided by a stabilisation and subsequent slight drop in energy prices and a fall in foreign industrial producer price inflation. A later drop in import prices will start to dampen growth in total costs.
The growth in Czech firms’ costs is also due to a large extent to domestic factors, especially persisting slight labour market tightness. The unemployment rate remains very low and firms are facing labour shortages despite the rapid integration of many tens of thousands Ukrainian refugees into the labour force.
These factors will be reflected in wage agreements. This will later cause the already relatively buoyant wage growth in market sectors to pick up even further. This process will also be fostered by rising labour productivity and further increases in the minimum wage and the cascade of guaranteed wages above it. Nominal earnings will thus markedly outpace their long-term trend over the next two years. Even so, they will initially lag well behind inflation, so real wages will decline sharply.
The Czech economy will continue to operate amid persisting problems in global logistics and supplies of materials and components for production. Given its significant industrial orientation, these problems will dampen growth in total domestic economic activity until mid-2023. However, their impact on GDP will be smaller than last year and will gradually disappear next year. Despite increasing numbers of Covid-positive cases, the forecast does not expect the government to introduce anti-epidemic measures having a tangible dampening effect on domestic economic activity. Fiscal policy will reduce economic growth slightly this year, as the measures previously adopted to support the economy have been discontinued. Government expenditure to offset the impact of higher energy prices on households and firms and to support refugees will have the opposite effect. The forecast assumes that fiscal policy will have a slightly expansionary effect next year, mainly due to continued provision of energy compensation.
Economic growth will slow this year, despite buoyant investment activity. Still relatively favourable business sentiment, recovering external demand and continuing efforts by firms to automate production will foster growth in corporate investment. Government investment will also rise (with some fluctuations), supported by absorption of EU funds. However, stocks of unfinished products will be highly volatile due to global logistics problems. Household consumption will decline this year. On the one hand, growth in households’ nominal income will remain more than solid throughout the year, still supported by buoyant wage growth. Household income will also be boosted by a further reduction in income tax, an increase in pensions, expanded housing benefits and government programmes to mitigate the impact of expensive energy. On the other hand, family budgets will continue to face further rapid, broad-based growth in prices. Spending of households’ income and savings due to concerns of a loss of their purchasing power will be dampened by higher interest rates, lower consumer appetite and worse sentiment. Growth in exports and imports of goods and services will also remain subdued this year, owing to persisting logistics global problems. The Czech economy will thus grow by around 2% overall this year. Next year, the decline in household consumption will moderate somewhat due to a gradual decrease in inflation and a rise in nominal wage growth. Swift export growth will resume as the global logistics problems unwind, leading to a significant positive contribution of net exports. However, total investment will drop sharply owing to a sizeable decline in additions to inventories, and growth in fixed investment will slow as well. GDP will thus grow by around 1% next year. Economic growth will rise to 4% in 2024, driven mostly by renewed rapid growth in household consumption and a further visible increase in net exports.
The slowdown of the Czech economy causes the positive output gap to close quickly this year. The persisting supply-side constraints will slow potential growth. The economy will subsequently drop temporarily below its potential, causing the unemployment rate to edge up. This drop will be due to a cooling of the previously strong domestic demand pressures. The latter will be aided by the previous sharp growth in market interest rates, which is limiting the pass-through of inflation pressures to prices in the longer term and supporting the anchoring of inflation expectations.
In recent months, the koruna has faced depreciation pressure, which the CNB has successfully countered by intervening in the foreign exchange market. The koruna exchange rate will stay close to CZK 24.7 to the euro during the summer and then weaken in the subsequent quarters as a result of an exceptionally wide current account deficit and an expected narrowing of the interest rate differential vis-à-vis the euro area. The koruna will start to appreciate again moderately in late 2023. In a context of receding inflation pressures in the Czech economy, and with the prospect of inflation falling rapidly in 2023 and 2024, the CNB’s interest rates will be able to start decreasing in 2023.
A further rise in commodity prices, a threat of inflation expectations becoming unanchored, a related risk of a wage-inflation spiral and easier fiscal policy are upside risks to inflation. By contrast, the growing likelihood of recession abroad and a stronger-than-forecasted downturn in domestic consumer and investment demand are downside risks. The general uncertainties of the outlook include the future course of the war in Ukraine, the availability and prices of energy, the future monetary policy stance abroad and the duration of the disruptions to global supply chains.
Chart – Inflation will exceed 20% in late summer/early autumn and then start to fall rapidly, declining close to 2% over the monetary policy horizon
headline inflation; y-o-y in %; confidence intervals in colours
In this forecast, the monetary policy horizon is 18–24 months ahead.
Table – Economic growth will be subdued this year and the next and pick up visibly in 2024
y-o-y changes in % (unless otherwise indicated); changes in pp compared to previous forecast in brackets
|Headline inflation (%)||16.5||9.5||2.4|
|Average nominal wage||4.5||6.2||7.5|
|3M PRIBOR (%)||6.2||5.2||3.1|
|Exchange rate (CZK/EUR)||24.8||25.7||25.5|