CNB issues Inflation Report I/2017

The new forecast assumes 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 until mid-2017. Consistent with the forecast is an increase in market interest rates thereafter.
According to the forecast, inflation will increase further into the upper half of the tolerance band around the target and return to the target from above at the monetary policy horizon. According to the new forecast, sustainable fulfilment of the 2% inflation target in the future, after the assumed return to the conventional monetary policy regime, will occur from around mid-2017 onwards.
The growth of the Czech economy eased further in 2016 Q3. According to the forecast, it reached 2.4% in 2016 as a whole. This slowdown was due mainly to a temporary drop in government and corporate investment financed from EU funds. The rate of growth will increase to almost 3% in the next two years.
The continued economic growth will lead to a further increase in wage growth. The unemployment rate will decrease only slightly.
The Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being balanced.
The Bank Board stated again that the Czech National Bank will not discontinue the use of the exchange rate as a monetary policy instrument before 2017 Q2. The Bank Board still considers it likely that the commitment will be discontinued around the middle of 2017.

At its meeting on 9 February 2017, 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.

At the end of last year, domestic inflation accelerated sharply and returned to the target. The rise in inflation was due to a recovery in food price growth, an unwinding of the year-on-year fall in fuel prices and an increase in core inflation, i.e. adjusted inflation excluding fuels, which primarily reflected growth in the domestic economy and wages. According to the forecast, inflation will increase further into the upper half of the tolerance band around the target and return to the target from above at the monetary policy horizon, i.e. in the first half of 2018. According to the new forecast, the conditions for sustainable fulfilment of the inflation target in the future, after the assumed return to the conventional monetary policy regime, will be met from around mid-2017 onwards.

Monetary policy-relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will deviate only marginally from headline inflation.

The growth of the Czech economy eased further in 2016 Q3 and reached 2.4% in 2016 as a whole according to the forecast. This was due mainly to a temporary drop in government and corporate investment co-financed from EU funds. The rate of growth will increase to almost 3% in the next two years. The economy will be supported by continued growth in external demand, a gradual renewal of growth in government investment and still easy monetary conditions. However, the monetary conditions will start to shift towards a neutral effect following the assumed discontinuation of the exchange rate commitment in mid-2017. The continued economic growth will lead to a further increase in wage growth. The unemployment rate will decrease only slightly.

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 mid-2017. 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 balanced. The main uncertainty is the evolution of the koruna exchange rate following the exit from the exchange rate commitment, which may fluctuate in either direction in the short term. The CNB will stand ready to use its instruments to mitigate potential excessive exchange rate fluctuations following the exit from the commitment.

A need to maintain expansionary monetary conditions persists. The Bank Board therefore stated again that the CNB would not discontinue the use of the exchange rate as a monetary policy instrument before 2017 Q2. The Bank Board still considers it likely that the commitment will be discontinued around the middle of 2017.

Marek Zeman
Director, CNB Communications Division