Inflation will slow down significantly this year

At its February meeting, the Bank Board kept the two-week repo rate unchanged at 7%. The decision is based on the baseline scenario of the CNB’s winter macroeconomic forecast. In the forecast, the central bank looks at a monetary policy horizon 12–18 months ahead. The horizon is thus currently the first half of 2024, as in the previous two forecasts. The distance between the decision-making moment and the monetary policy horizon has been shortened by one quarter compared to the previous forecast. This mainly reflects easing external cost pressures. Consistent with the winter forecast is a rise in market interest rates initially, ensuring robust fulfilment of the inflation target next year. In expectation of the latter, interest rates will be able to start coming down in the course of this year. Domestic economic activity will decrease in the first half of this year, as economic output will be dampened by a worsening financial situation of households, slowing external demand and receding problems in global value chains. Inflation will rise again in early 2023, mainly because of a rise in electricity prices. It will then slow sharply due to decreasing foreign and domestic cost pressures, dropping to single digits in the second half of 2023. Inflation will decline to the CNB’s 2% target at the monetary policy horizon. The Bank Board assessed the uncertainties and risks of the baseline scenario of the winter macroeconomic forecast as being significant and going in both directions.

The exceptionally strong price pressures in the Czech economy have started to ease after peaking last year. This is being fostered by a decline in global inflation pressures amid a dampening of domestic and external demand together with energy consumption savings and the mild winter so far. Import prices of energy, which have been a major cost factor up to now, will begin to reduce inflation gradually. The decrease in inflation pressures will also be due to slower growth in domestic costs. However, the latter will remain elevated, as wage growth will fall only gradually.

Consumer price inflation is showing considerable volatility at the turn of the year due to movements in energy prices. Inflation fell in autumn 2022 owing to the inclusion of a government measure to help with the high energy prices (the energy savings tariff). This was reflected in a temporary but sizeable drop in electricity prices in Q4. Administered price inflation – and hence also consumer price inflation – will rise again in early 2023. This will be caused mainly by a rise in electricity prices, which will stop at the government price cap that replaces the energy savings tariff. At the same time, the usual January repricing of goods and services will be above the long-term average.

Consumer price inflation will rise again in January, exceeding 17%. However, it will start to fall in the subsequent months, dropping to single digits in the second half of the year. In the first half of 2024, inflation will decline to the CNB’s 2% target, with all its components contributing. Core inflation started to come down in 2022 Q4, and a continued decrease will be fostered by diminishing growth in foreign producer prices and cooling domestic demand. The contribution of imputed rent is falling rapidly, fully reflecting the previous interest rate increases, which have slowed growth in house purchase loans and property prices. Declining global agricultural commodity prices and domestic agricultural producer prices will foster a further slowdown in food price inflation, which peaked in November 2022. Fuel prices will start to decline year on year in 2023 Q1. Administered price inflation will be extremely high and volatile this year and will not decline significantly until next year.

The Czech economy will contract overall this year. The downturn will be concentrated mainly in the first half of the year, due to falling household consumption expenditure and gross investment. Czech households are facing a deep decline in real income, which is being partly offset by government support. This, together with negative sentiment, is being reflected in a decline in their consumption. Fixed investment will fall in the first half of the year owing to a downturn in external demand and worse business sentiment. The cooling of external demand will hold back export activity in early 2023. However, exports will gradually be supported in the first half of this year by the fading of problems with global logistics and supplies of materials and components for production. Those problems have been weighing heavily on industry, fostering higher additions to inventories. The downturn in domestic demand will cause import growth to lag well behind export growth this year. The contribution of net exports to economic growth will be strongly positive in 2023. It will continue to support GDP growth slightly in 2024.

Fiscal policy will make a slightly positive contribution to GDP growth overall this year, despite the fading out of part of last year’s support expenditure. This is because the effect of the government measures to fight high energy prices and the addition of a child-raising bonus to pensions will dominate. In 2024, by contrast, fiscal policy will dampen economic growth due to the termination of the support measures and an only slow start to the absorption of investment from EU funds in the new programme period.

The previous overheating of the Czech economy dissipated as its growth slowed last year. By the close of the year, the economy was operating below its potential, the growth of which was adversely affected by the problems in international logistics and in the supply of materials and production components. The output gap will stay negative until mid-2024. The labour market is also cooling and its tightness will decrease slightly further. The economic downturn is fostering a drop in labour demand. The decline in employment and gradual rise in unemployment will continue this year. The excess demand for labour will decrease further. Nominal wage growth, which rose sharply at the close of last year, will remain high over the next two years. The bargaining position of employees will stay strong for some time. Firms’ still good financial condition and a further increase in the minimum wage in January 2023 will also foster buoyant wage growth. However, the scope for wage increases in firms will be reduced by high energy prices and lingering problems in global value chains. As a result, wages will catch up only gradually with inflation and will start to rise in real terms at the end of this year.

The koruna appreciated in late 2022 and early 2023. This was due to a correction of energy prices caused by the mild winter, among other factors, and to better market sentiment related to the CNB’s declaration that it was ready to prevent excessive fluctuations of the koruna. The koruna will weaken slightly this year, mainly as a result of a narrowing interest rate differential vis-à-vis the euro area. The exchange rate will strengthen gradually in 2024 as the high energy prices and the problems in global value chains unwind.

Consistent with the forecast is a rise in market interest rates initially, followed by a gradual decline. The temporary rise in interest rates reflects the fading extraordinary inflation pressures and the central bank’s effort to fulfil the 2% inflation target at the monetary policy horizon. In the course of 2023, CNB interest rates will be able to start coming down in expectation of inflation stabilising at the target in 2024.

There are numerous substantial risks and uncertainties associated with the forecast. More expansionary fiscal policy is an upside risk. The threat of inflation expectations becoming unanchored and the related risk of a wage-price spiral also remain significant risks in the same direction. By contrast, a stronger-than-forecasted downturn in domestic consumer and investment demand is a downside risk. A faster-than-expected decline in core inflation is also an anti-inflationary risk. The extent of repricing of goods and services in January, which will affect annual inflation throughout 2023, is a risk in both directions. The general uncertainties of the outlook include the future course of the war in Ukraine, the availability and prices of energy, and the future monetary policy stance abroad.

Chart – Inflation will rise again in 2023 Q1 and then start to fall, dropping to the 2% target in the first half of 2024
headline inflation; y-o-y in %; confidence intervals in colours

Table – Following a slight decrease in output this year, the economy will start to grow again in 2024
y-o-y changes in % (unless otherwise indicated); changes in pp compared to previous forecast in brackets