CNB issues Inflation Report II/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 mid-2017. Consistent with the forecast is an increase in market interest rates thereafter.
• According to the forecast, both headline and monetary policy-relevant inflation will start to increase at the end of this year, hitting the 2% target at the monetary policy horizon and then moving slightly above it.
• GDP growth will slow markedly this year, due mainly 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 slightly anti-inflationary.
• The Bank Board therefore stated that the CNB would 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 mid-2017.
• The CNB stands ready to move the exchange rate commitment to a weaker level if there were to be a systematic decrease in inflation expectations manifesting itself in nominal variables, especially wages.

At its meeting on 12 May 2016, the Bank Board of the Czech National Bank approved this year’s second 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 decline temporarily again close to zero in the near future owing to a renewed decrease in administered prices, a temporary deepening of the decline in food prices and a temporary slowdown in adjusted inflation excluding fuels. However, they will start to rise at the close of this year, hitting the 2% target at the monetary policy horizon, i.e. in 2017 Q2 and Q3, and then slightly exceeding it. The domestic economy will continue to foster a rise in consumer prices via accelerating wage growth. At the same time, the current strongly anti-inflationary effect of import prices will fade gradually. According to the forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will occur from mid-2017.

The growth of the Czech economy will slow to 2.3% this year from the exceptionally high level recorded last year. This will be due mainly to a fall 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, growth in economic activity will continue to be supported by easy domestic monetary conditions, low oil prices and rising external demand. After the fall in government investment fades out, GDP growth will accelerate to over 3% next year. The rising economic activity will manifest itself in continued growth in employment. This will result in a further, albeit only modest, decrease in the unemployment rate. Wages will rise at a steady pace this year and accelerate further next year.

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 slightly anti-inflationary. Producer price inflation in the euro area is a significant risk. It may be more subdued than currently assumed, as has been the case several times in the recent past. In addition, the risk of undesirable second-round effects of foreign cost factors is rising as the duration of the period of very low inflation increases, although those factors primarily represent favourable supply shocks. The central bank reacts to any adverse second-round effects of such cost factors, unlike to their immediate price effects. In this context, the Bank Board pointed out that the CNB stands ready to shift the exchange rate commitment to a weaker level if there were to be a systematic decrease in inflation expectations manifesting itself in nominal variables, especially wages.

A need to maintain expansionary monetary conditions at least to the current extent persists. At the same time, the Bank Board stated again that the CNB would 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 mid-2017, i.e. in line with the assumption of the new forecast.

• 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