The CNB’s current macroeconomic outlook and its risks

At its November meeting, the Bank Board kept the two-week repo rate unchanged at 7%. The decision is based on the CNB’s autumn macroeconomic forecast. In the baseline scenario of that forecast, due to the recent extraordinary but not escalating external cost pressures, the central bank is currently looking at a monetary policy horizon 15–21 months ahead, i.e. one quarter closer to the time of the decision than in the previous forecast. It is thus setting interest rates with regard to inflation in the first half of 2024, as in the summer forecast. Consistent with the forecast is a rise in market interest rates, followed by a gradual decline in the course of next year. The Czech economy is beginning to cool down in the context of a global slowdown and a drop in households’ real income, but domestic and above all foreign inflation pressures remain strong. Inflation will peak at the end of this year. In the course of next year, it will decline rapidly from double-digit levels, due to diminishing growth in costs, cooling external demand and the previous tightening of domestic monetary policy, which are helping to dampen domestic demand and the labour market. In the first half of 2024, inflation will decline close to the CNB’s 2% target. The Bank Board assessed the uncertainties and risks of the baseline scenario of the autumn macroeconomic forecast as being significant and going in both directions.

The Czech economy is facing peaking inflation pressures causing further growth in the inflation rate. Housing-related energy prices continued to rise apace in Q3, reflecting still very high prices on energy exchanges. Growing energy costs and high global agricultural commodity prices and domestic agricultural producer prices fostered a further pick-up in food price inflation. By contrast, core inflation did not rise any further in Q3. The exceptionally large contribution of the cost of owner-occupied housing, which reflects prices in the construction and real estate sectors, started to edge down in Q3. Lower oil prices and margins along the entire value chain also led to lower fuel price growth.

The unprecedented growth in total costs faced by Czech firms peaked in Q2 and then eased slightly. Growth in import prices and domestic intermediate goods prices is slackening. The decline in the growth in costs is also due to a fading of the problems in global value chains. Growth in domestic costs is also slowing somewhat on the back of gradually cooling demand, although wage growth remains solid. The practice of domestic producers, retailers and service providers of incorporating growth in costs into their prices – and, in some cases, improving their profit margins on top of that – will cease to grow in intensity. The rising global prices of electricity and gas are gradually affecting firms. Cost pressures in the corporate sector will remain strong by historical standards for the rest of 2022 but will then weaken fairly quickly.

Inflation will peak at the end of this year, averaging more than 18% in Q4. A rise in administered price inflation caused by renewed growth in housing-related energy bills will be partly offset by a waiver of the fees for renewable energy sources. At the same time, the government will partly compensate households for the growth in gas, electricity and heat prices for the rest of 2022 using the savings tariff now in place.

At the start of 2023, the government will cap electricity and gas prices to help with the high energy prices. This will reduce the growth in gas prices for households in particular, and administered price inflation will thus start to moderate. However, the other components of inflation will also cool down. A rapid slowdown in inflation to single figures from mid-2023 will be fostered by a further easing of cost pressures and by a cooling of foreign economic growth, domestic demand and the local labour market, reflecting, among other things, tighter domestic monetary policy. 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.

The Czech economy faces persisting problems with global logistics and supplies of materials and components for production, especially in industry. These problems have stopped escalating but remain high in intensity. The forecast assumes that they will keep diminishing and fade out completely in mid-2023. Until then, however, they will drag on Czech exports and total domestic economic activity.

Fiscal policy will dampen economic growth slightly this year. The restrictive effect of the discontinuation of the support measures adopted during the pandemic will be slightly stronger than the pro-growth effect of government expenditure on mitigating the impacts of the high energy prices on households and firms and on supporting refugees. In particular, the extension of the some of the energy compensation measures, coupled with growth in social spending, will cause fiscal policy to have a slightly positive effect next year.

Domestic economic activity fell quarter on quarter in Q3. It will switch to a year-on-year decline at the end of the year and keep falling for several quarters. In whole-year terms, the output of the Czech economy next year will be lower than this year. This will be due to dramatic growth in living costs, a worsening financial situation of households and firms, cooling external demand and persisting global value chain problems. Household consumption will drop owing to falling real income and worsening sentiment. It will be prevented from decreasing more sharply by buoyant wage growth in the private and public sector and by fiscal support in the area of energy prices, repeated pension increases and growth in other social benefits. Faced with great uncertainty and a worse financial situation, firms will rein in investment. By contrast, additions of unfinished products to inventories will remain high in the quarters ahead, amid only slowly fading global logistics problems. Besides these issues, exports will be affected very adversely by a sizeable weakening of euro area demand and an expected renewed rise in energy market tensions at the start of winter 2023/2024. Firms will be able to rapidly complete and export their forced stocks of unfinished products as the production input shortages lessen. The positive contribution of net exports to economic growth will then increase and, together with recovering household consumption, will be the main driver of renewed economic growth in 2024.

The previous overheating of the Czech economy will subside quickly. In an environment of recession, the output of the Czech economy will fall below potential. Labour market tightness will also ease. Job creation will decline and employment will start to fall slightly next year. The current excess demand for labour will thus disappear and the unemployment rate will go up gradually. Despite this, nominal wage growth will be fairly high by historical standards over the next two years. The bargaining position of employees will remain strong for some time. However, the ongoing energy shock, which will hit the currently solid financial situation of firms in late 2022 and early 2023, will limit the room for wage increases. Wages will thus catch up only slowly and partially with the previous growth in prices in the years ahead.

Over the past six months, the koruna has been facing depreciation pressure, which the CNB has countered by intervening occasionally in the foreign exchange market. The exchange rate will stay close to CZK 24.6 to the euro during the autumn and remain broadly flat in the subsequent quarters. Consistent with the forecast is a rise in market interest rates, followed by a gradual decline in the course of next year. In a context of receding inflation pressures in the Czech economy, and with the prospect of inflation falling rapidly to the CNB’s 2% target over the subsequent two years, the CNB’s interest rates will be able to start decreasing.

The Bank Board assessed the risks and uncertainties of the baseline scenario of the forecast as being significant and going in both directions. The upside risks to inflation include faster-than-forecasted wage growth, more expansionary fiscal policy and a higher outlook for foreign producer prices. The threat of inflation expectations becoming unanchored and the related risk of a wage-price spiral remain significant risks in the same direction. By contrast, the growing likelihood of recession in the Czech Republic and abroad and hence a stronger-than-forecasted slowdown in domestic consumer and investment demand are downside risks. The introduction of additional measures to limit growth in energy prices at the domestic or European level and a faster-than-expected decline in core inflation are additional anti-inflationary risks. 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 peak at the end of this year and fall rapidly in the course of next year, declining close to the CNB’s 2% target over the monetary policy horizon
headline inflation; y-o-y in %; confidence intervals in colours

In this forecast, the monetary policy horizon is 15–21 months ahead.

Table – The output of the Czech economy will decline next year; economic growth will resume in 2024
y-o-y changes in % (unless otherwise indicated); changes in pp compared to previous forecast in brackets