CNB issues Inflation Report I/2015

• The new forecast is based on an assumption that market interest rates will be flat at their current very low level and the koruna exchange rate will be used as a monetary policy instrument over the entire forecast horizon.
• Both headline and monetary policy-relevant inflation will be at zero or slightly negative levels in 2015. In 2016, inflation will rise to the CNB’s 2% target amid an unwinding of the year-on-year fall in oil prices and of the deflationary tendencies in the euro area combined with continued growth in domestic economic activity and gradually accelerating wage growth.
• Thanks to recovering external demand, low oil prices, easy domestic monetary conditions and expansionary fiscal policy, GDP will grow by 2.6% this year and pick up to 3% in 2016. The growing economic activity will be reflected on the labour market in an increase in employment, a gradual decline in the unemployment rate and accelerating wage growth in the business sector.
• The Bank Board assessed the risks to the new forecast as being balanced, although the degree of uncertainty has increased. The slump in oil prices is a positive supply shock which will boost Czech economic growth in 2015. The Czech National Bank will not respond to the first-round effects of this shock on the price level. It remains the CNB’s intention to ensure that inflation returns towards the 2% target at the monetary policy horizon. Therefore, it will be important to prevent any second-round effects of the slump in energy commodity prices.
• The Bank Board therefore again stated that the level of the exchange rate commitment could be moved. From this perspective, the effectiveness of the European Central Bank’s measures to combat deflation, the market evolution of the koruna exchange rate and domestic wage developments will be crucial in the period ahead. The Bank Board also stated that the CNB would not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016.

At its meeting on 12 February 2015, 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 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 expects both headline and monetary policy-relevant inflation to be at zero or slightly negative levels in 2015 and then rise to the 2% target in 2016. The overall upward pressures on consumer prices will almost disappear in the near term, as a decline in producer prices in the euro area coupled with a fall in global prices of energy commodities will result in a substantial decrease in costs stemming from import prices. The anti-inflationary effect of import prices will subside at the start of 2016. Continued growth in domestic economic activity and gradually accelerating wage growth will foster higher prices this year and the next.

Accelerating external demand, low oil prices, easy domestic monetary conditions via the weakened koruna and exceptionally low interest rates, and expansionary fiscal policy will lead to GDP growth of 2.6% this year. Output growth will accelerate to 3% in 2016 despite falling government investment, thanks mainly to a pick-up in external demand growth. The labour market situation will improve thanks to the continuing growth in economic activity, which will be reflected in growth in employment, a gradual decline in the unemployment rate and a rise in wage growth in the business sector.

The exchange rate of the koruna against the euro is expected to be stable in the next few quarters at a similar level to that observed last year, slightly weaker than the announced asymmetric exchange rate commitment of CZK 27 to the euro. The forecast expects the exchange rate to be used as a monetary policy instrument over the entire forecast horizon. The return to conventional monetary policy should not imply appreciation of the exchange rate to the level recorded before the CNB started intervening, as domestic inflationary pressures should be sufficiently restored in the meantime owing to a recovery in domestic economic activity and wage growth. The forecast also expects market interest rates to be flat at their current very low level until the end of 2016, reflecting an assumption that the 2W repo rate will be left at technical zero and the money market premium will be kept unchanged in the same period.

The Bank Board considers the risks to the new forecast to be balanced, although the degree of uncertainty has increased. Uncertainty is associated above all with the effects of the measures adopted by the European Central Bank and with the future evolution of domestic wages in an environment of very low inflation and a positive cost shock in the shape of the slump in oil prices. This slump is a positive supply shock which will boost Czech economic growth in 2015. The CNB will not respond to the first-round effects of this shock on the price level. This means it is prepared to tolerate inflation moving temporarily close to, or even slightly below, zero this year. Next year, however, the first-round effects of this shock will unwind, and it remains the CNB’s intention to ensure that inflation returns towards the 2% target. Therefore, it will be important to prevent any second-round effects of the current slump in energy commodity prices, which would be reflected in inflation in the longer run. In this situation, the Bank Board stated that the CNB would not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016. The Czech National Bank stands ready to move the level of the exchange rate commitment if there were to be a long-term increase in deflation pressures capable of causing a slump in domestic demand, renewed risks of deflation in the Czech economy and a systematic decrease in inflation expectations.

• Full text of the Inflation Report (pdf, 3 MB)
  
• Tables and charts from the Inflation Report (xls)
• Table of key macroeconomic indicators (xls, 70 kB)
• Current CNB forecast

Tomáš Zimmerman
CNB spokesman

Selected macroeconomic indicators