CNB issues Inflation Report II/2017

Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3 and later also in 2018.
According to the forecast, inflation will stay in the upper half of the tolerance band for the rest of this year. It will then decline towards the 2% target and will be very close to it over the monetary policy horizon.
The growth of the Czech economy will rise to almost 3% this year. The domestic economy will maintain a similar pace next year.
The continued domestic economic growth will manifest itself in rising tightness in the labour market. This will result in a further acceleration in wage growth.
The Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being slightly inflationary. Future interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna.
The CNB still stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed.

At its meeting on 10 May 2017, 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.

According to the forecast, domestic inflation will stay in the upper half of the tolerance band for the rest of this year. It will decline towards the 2% target at the start of next year and will be very close to it over the monetary policy horizon, i.e. in 2018 Q2 and Q3. In addition to core inflation, rapid growth in food and fuel prices is contributing to the higher inflation this year. The expected decline in inflation in early 2018 will be due to an unwinding of one-off factors observed in late 2016 and early 2017. It will be supported by a recovery in labour productivity growth, which will reduce the currently peaking cost pressures from the domestic economy. A renewed anti-inflationary effect of import prices connected with the forecasted appreciation of the koruna will act in the same direction.

The growth of the Czech economy will rise to almost 3% this year. The domestic economy will maintain a similar pace next year. Growth in economic activity will be driven mainly by robust growth in household consumption and a gradual recovery in investment. The economy will benefit from further growth in external demand. The continued domestic economic growth will manifest itself in rising tightness in the labour market. This will result in a further acceleration in wage growth.

The forecast assumes that interest rates will remain at the current level in Q2 following the exit from the exchange rate commitment in April. Thereafter, an increase in domestic market interest rates in 2017 Q3 and later also in 2018 is consistent with the forecast. The rate increase will be strongly dampened until around mid-2018 by the European Central Bank’s currently ongoing quantitative easing. According to the forecast, the koruna will appreciate due, among other factors, to continued real convergence of the Czech economy to the euro area countries. According to the forecast, appreciation will also be fostered by a positive interest rate differential vis-à-vis the euro area and this year’s asset purchases by the European Central Bank. However, the exchange rate forecast does not take into account that the appreciation may also be strongly dampened in the coming quarters by market “overboughtness”.

The CNB Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being slightly inflationary. The path of the exchange rate is still the main uncertainty of the forecast. The exchange rate may fluctuate in either direction after returning to the standard form of managed floating. Compared to the forecast, it may be weaker on average owing to the absence of a counterparty for the closing of koruna positions by financial investors. The extent to which the current inflation pressures are fundamental and persistent is also uncertain. The uncertainties regarding future economic developments also include domestic and foreign political risks.

The exit from the exchange rate commitment was the first step towards a gradual return of the overall monetary conditions to normal. Subsequent interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna. The CNB still stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed.

Marek Zeman
Director, CNB Communications Division