CNB issues Inflation Report III/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, inflation will start to rise in the near future and slightly exceed the 2% target at the monetary policy horizon. It will then return to the target from above.
• GDP growth will slow this year, due mainly to a drop in government investment financed from EU funds. Economic growth will pick up again 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 balanced.
• 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. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017.

At its meeting on 11 August 2016, the Bank Board of the Czech National Bank approved this year’s third 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.

Domestic inflation will start to rise in 2016 Q3 due to increasing domestic activity and wages amid a fading anti-inflationary effect of import prices. Inflation will slightly exceed the 2% target at the monetary policy horizon, i.e. 12–18 months ahead, and then return to the target from above. According to the new forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will occur in mid-2017. Monetary policy-relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will differ only marginally from headline inflation. Monetary policy-relevant inflation will therefore also slightly exceed the target at the monetary policy horizon.

The growth of the Czech economy slowed markedly in 2016 Q1 and will moderate further in the rest of the year according to the forecast. This is because gross capital formation will decline this year owing to a drop in government investment co-financed from EU funds. By contrast, the economy continues to be supported by still easy monetary conditions, low commodity prices and rising external demand. After the drop in government investment unwinds, economic growth will pick up to 3% next year amid still robust household consumption. The economy will then grow at the same pace in 2018. The rising economic activity will manifest itself in continued growth in employment, although its pace will slow. This will result in a further, albeit only modest, decrease in the unemployment rate. Wage growth will accelerate further in both the business and non-business sectors.

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 uncertainties of the forecast include the impacts of the outcome of the UK referendum on external demand, the effect of the domestic election cycle on expenditure growth and the depth of the fall in government investment this year. At the same time, the uncertainty surrounding the impact of the long-lasting low inflation on the anchoring of inflation expectations has declined somewhat. In this context, however, the CNB still 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. 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. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017.

• Full text of the Inflation Report (pdf, 3.4 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