Inflation will stay close to the CNB’s 2% target over the entire forecast horizon

At its August meeting, the Bank Board lowered the two-week repo rate by 0.25 pp to 4.5%. Inflation has stabilised close to the CNB’s target, standing at 2% exactly in June. Elevated growth persists only in prices of market services within core inflation and in some items of administered prices. Prices in the rest of the consumer basket are rising modestly or falling. Economic growth continues to recover at a moderate pace. GDP growth this year will be supported mainly by accelerating household consumption. Next year, investment will also start growing again amid recovering external demand and falling domestic and foreign rates. The tightness in the domestic labour market is easing only gradually, while brisk nominal and real wage growth is fostering a recovery in employees’ purchasing power, which was suppressed by the previous inflation. Consistent with the summer forecast is a modest decline in short-term market interest rates. It will ensure robust fulfilment of the inflation target over the entire outlook. The Bank Board assessed the risks and uncertainties of the forecast as broadly balanced overall.

Inflation has stabilised close to the CNB’s 2% target. It became anchored exactly at the target in June and will stay very close to it over the next few months. Inflation will increase slightly at the end of the year as last year’s exceptionally subdued price growth drops out of the year-on-year comparison. Headline inflation will stay near 2% over the next two years.

The near-target inflation reflects the fade-out of the previous strong supply shocks, which are now evident only in elevated growth in prices of market services. Domestic demand pressures remain subdued, thanks in part to tight monetary policy. In this environment, firms’ profit margins, which until recently were fuelling inflation, are decreasing.

Food, beverage and tobacco prices are seeing a partial correction of their previous strong growth. They are falling slightly in year-on-year terms due to subdued growth in food commodity prices and weaker demand. However, they will start to go up again at the year-end. Fuel prices are rising only slightly and market outlooks for oil prices indicate a downward trend in the future. Cuts in energy prices for households by large suppliers are partially offsetting the growth in other administered prices. The situation will be similar next year.

Core inflation will be stable near 2%. Prices of most market services within core inflation continue to rise apace. This is an aftershock of the previous wave of inflation. By contrast, tradables prices are now falling. The gap between market services inflation and goods inflation will persist into the future. However, it will not pose an additional inflationary risk, as it is a result of renewed growth in labour productivity in the Czech economy and convergence towards more advanced countries (albeit at a slower pace than before). Faster growth in property prices linked with renewed demand on the property market and a recovery in mortgage lending may nevertheless become a risk. Its materialisation amid steady growth in prices of other market services could cause core inflation to accelerate again.

The Czech economy continues to recover at a moderate pace. GDP growth will reach 1.2% this year and rise to 2.8% next year. It will be driven by strengthening growth in household consumption linked to growth in real wages following a long period of decline. A further recovery in consumer demand will be supported by the falling interest rates and stable low-inflation environment.

Investment will also start to grow again next year. It will benefit from rising external demand, falling domestic and foreign interest rates and the start of implementation of projects financed from EU funds in the new programme period and under the National Recovery and Resilience Plan. Growth will thus be driven by both private and public investment. The contribution of additions to inventories will also turn positive again.

The slowly recovering external demand will support export growth. However, the strengthening domestic demand will – via its import intensity – result in net exports starting to slow GDP growth next year. Fiscal policy is dampening economic growth this year due to budget consolidation. Its effect will be broadly neutral in the years ahead.

Starting with this forecast, the estimate of the long-term potential output growth of the Czech economy is reduced by 0.5 pp to 2.5%. The main reason is the gradual exhaustion of its previous growth model and a related slowdown in labour productivity growth. The reasons for, and context of, this shift are analysed in more detail in the Appendix to the Summer 2024 MPR.

The tightness in the labour market is easing only slowly. The unemployment rate is gradually rising and will increase slightly further next year. It will thus reflect the recent contraction of the Czech economy with a lag. Wage growth in market services will be brisk this year, exceeding 8%. However, this will merely imply a recovery in employees’ purchasing power, which was suppressed by the previous wave of inflation.

Growth in the general government wage bill remains subdued but can be expected to accelerate in the future. However, the extent and timing of the acceleration are to some extent uncertain and will be the subject of further political negotiations. Faster-than-expected growth in public sector pay and potential higher growth in other government expenditures next year (an election year) represent another risk of the forecast.

The koruna depreciated slightly above CZK 25 to the euro in the past few months. The depreciation was due to a revision of the expected pace of cuts in the CNB’s key interest rates by market participants (in which the June inflation data played a role) and a rise in the outlook for ECB rates. However, recent developments and the ECB’s communications do not rule out a drop in rates in September. The short-term exchange rate outlook is CZK 25.2 to the euro. The forecast expects the rate to stay close to this level for the rest of the year. The koruna will then start to appreciate slightly again.

Consistent with the summer forecast is a modest decline in short-term market interest rates. Even so, monetary policy – given that inflation is at the target level and inflation expectations have stabilised – will be restrictive. This will ensure robust fulfilment of the inflation target over the entire outlook.

The Bank Board assessed the risks and uncertainties of the forecast as broadly balanced overall. Increased wage demands in the private and public sector are an inflationary risk. Potential excessive growth in total public sector spending would also lead to a risk of the state budget having an inflationary effect. Higher-than-expected inertia in services inflation and a halt in tradables disinflation, which has so far been due mainly to fading supply-side problems, are additional upside risks. An inflationary risk in the longer term is a potential acceleration of money creation in the economy stemming from a significant recovery in lending activity, especially on the property market. By contrast, a downturn in global economic activity and weaker German – and hence Czech – economic output are a significant downside risk to inflation. The future monetary policy stance abroad remains an uncertainty of the outlook.

Chart – Inflation will be close to the CNB’s 2% target over the entire outlook, including the monetary policy horizon
headline inflation; y-o-y in %; confidence intervals in colours

Table – The Czech economy will grow this year; GDP growth will accelerate to almost 3% next year
y-o-y changes in % (unless otherwise indicated); changes in pp compared to previous forecast in brackets