CNB issues Inflation Report I/2016

• The new forecast assumes that market interest rates will be flat at their current very low level and the exchange rate will be used as a monetary policy instrument until the end of 2016. Consistent with the forecast is an increase in market interest rates in 2017.
• According to the forecast, both headline and monetary policy-relevant inflation will increase, hitting the 2% target at the monetary policy horizon and then moving slightly above it.
• Despite a further drop in oil prices, GDP growth will slow markedly this year due to a drop in government investment financed from EU funds. Economic growth will accelerate slightly next year.
• The rising economic activity will manifest itself in the labour market in continued growth in employment, a decline in unemployment and a further pick-up in wage growth.
• The Bank Board assessed the risks to the forecast at the monetary policy horizon as being broadly balanced. The evolution of oil prices is a significant source of uncertainty in both directions.
• The Bank Board therefore states that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Bank Board considers it likely that the commitment will be discontinued in the first half of next year.

At its meeting on 11 February 2016, 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 increase, hitting the 2% target at the monetary policy horizon and then moving slightly above it. The domestic economy will continue to foster higher costs and consequently higher consumer prices, mainly via accelerating wage growth. At the same time, the current strongly anti-inflationary effect of import prices, stemming from a fall in producer prices in the euro area and in global commodity prices, will fade gradually. Adjusted inflation excluding fuels will thus increase to 1.7% by the end of this year and approach 2% in 2017. Food prices will also start rising again this year, while administered prices and fuel prices will return to growth in 2017. According to the forecast, the CNB’s 2% target will be reached at the start of 2017 and sustainable fulfilment of this target is a condition for a return to conventional monetary policy.

According to the forecast GDP growth will slow to 2.7% this year because of a temporary decline in gross capital formation due mainly to a drop in government investment as a result of an only gradual start to the drawdown of EU funds in the new programme period. On the other hand, the economy will be supported by still easy monetary conditions and the positive supply-side effect of low oil prices. GDP growth will pick up to 3% next year, with positive contributions from all components of domestic demand. The favourable economic developments will be reflected in a further improvement in the labour market situation. Total employment will continue to rise, albeit at a slowing pace. The decrease in unemployment will continue, although it too will decelerate. Wage growth in the business sector will accelerate further this year and will exceed that in the non-business sector.

The forecast assumes that market interest rates will be flat at their current very low level and the exchange rate will be used as a monetary policy instrument until the end of 2016. Consistent with the forecast is an increase in market interest rates after the exit from the exchange rate commitment.

The Bank Board assessed the risks to the forecast at the monetary policy horizon as being broadly balanced. The evolution of oil prices, which have recently seen marked fluctuations, is a significant source of uncertainty in both directions.

A need to maintain expansionary monetary conditions at least to the current extent persists. In view of the above, discontinuation of the exchange rate commitment earlier than assumed by the forecast, i.e. at the start of 2017, can now be ruled out. The Bank Board therefore states that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Bank Board considers it likely that the commitment will be discontinued in the first half of next year.

According to the forecast, the return to conventional monetary policy will not result in the exchange rate appreciating sharply to the slightly overvalued level recorded before the CNB started intervening, among other things because the weaker exchange rate of the koruna is in the meantime passing through to the price level and other nominal variables. At the same time, the Bank Board stated that any exchange rate appreciation following the discontinuation of the exchange rate commitment would be dampened, among other things, by hedging of exchange rate risk by exporters during the existence of the commitment, by the closing of koruna positions by financial investors and by possible CNB interventions to mitigate exchange rate volatility.

• Full text of the Inflation Report (pdf, 3.6 MB)
• Tables and charts from the Inflation Report (xlsx)
• Table of key macroeconomic indicators (xlsx, 70 kB)
• Current CNB forecast

Marek Zeman
Director, CNB Communications Division

Selected macroeconomic indicators