CNB issues Inflation Report I/2012

• The new macroeconomic forecast expects headline inflation to rise temporarily to just above 3% this year owing mainly to a VAT increase; it will then fall below the target at the start of 2013
  
• Monetary-policy relevant inflation will be close to the inflation target over the entire forecast horizon with a slightly declining tendency. The impacts of the VAT increase on inflation expectations and wages are not expected to be significant
  
• Domestic economic activity will be flat at the previous year’s level owing to a sizeable slowdown in external demand and continuing domestic fiscal consolidation; a recovery in external demand will foster renewed GDP growth in 2013 (of 1.9%)
  
• The nominal koruna-euro exchange rate is gradually appreciating over the forecast horizon from its currently weakened level reflecting the impacts of the euro area debt crisis
  
• Consistent with the forecast is stability of market interest rates in the near future and a modest decline thereafter

At its meeting on 9 February 2012, the Bank Board of the Czech National Bank approved this year’s first Inflation Report. The Report is one of the core elements of the central bank’s communication with the public in the inflation-targeting regime. An important part of the Inflation Report is a description of the CNB’s new quarterly macroeconomic forecast. The forecast is a key input for monetary policy decision-making. The inflation forecast and the assumptions underlying it are published with the aim of making monetary policy as transparent, comprehensible, predictable and therefore credible as possible. The CNB submits the Inflation Report to the Chamber of Deputies of the Czech Parliament twice a year for review.

The forecast described in section II of this Report expects annual headline inflation to rise temporarily to just above 3% owing to changes to indirect taxes. At the same time it assumes that part of the impact of the VAT increase from 10% to 14% as of January 2012 passed through to food prices in advance at the end of 2011. After the first-round effect of the VAT increase unwinds, headline inflation will fall below the inflation target of 2% in 2013. Monetary-policy relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will be close the inflation target over the entire forecast horizon with a slightly declining tendency, and will fall just below the target in 2013. The impacts of the VAT increase on inflation expectations and wages are not expected to be significant.

Economic activity is expected to be flat this year at the previous year’s level (i.e. zero GDP growth), reflecting a sizeable slowdown in external demand and continuing domestic fiscal consolidation. The subdued external demand will be reflected in negative contributions of net exports and investment in inventories. The other GDP expenditure components will record slightly positive contributions. Growth in real economic activity will resume in 2013 (1.9%) in connection with a recovery in external demand. Government consumption, which will fall owing to expected spending cuts, will be the only expenditure component that will not support GDP growth next year.

On the labour market, the aforementioned developments in economic activity will be reflected in a temporary dip in total employment in 2012 H2. Total employment will return to growth, albeit modest, in 2013 H2. This will lead to an only negligible decrease in the general unemployment rate. Average wage growth in the business sector will slow this year and pick up again in 2013 in line with the expected evolution of economic activity and employment. Wage growth in the non-business sector will be subdued in both years.

The nominal exchange rate against the euro will gradually appreciate from its currently weakened level reflecting the impacts of the euro area debt crisis. Consistent with the forecast is stability of market interest rates in the near future and a modest decline thereafter. Several factors, both from the domestic economy and from abroad, are fostering a decline in interest rates over the entire forecast horizon. These anti-inflationary pressures are offset in 2012 H1 by elevated inflation, including the outlook for administered prices, and by depreciation of the exchange rate. Interest rates do not react to the expected temporary rise in headline inflation above the target in 2012 caused by the first-round effects of the changes to indirect taxes, to which the escape clause mechanism applies as usual.

• Full text of the Inflation Report (pdf, 4,9 MB)
• Key macroeconomic indicators (xls, 80 kB)
• Tables and charts from the Inflation Report (xls)
• Current CNB forecast

Marek Petruš, CNB spokesman