CNB issues Inflation Report III/2017

According to the new CNB forecast, inflation will stay in the upper half of the tolerance band for the rest of this year and decrease towards the 2% target in early 2018.
The growth of the Czech economy will accelerate visibly above 3% this year and will stay slightly above 3% in the following two years.
Stable growth in labour demand coupled with an increasingly distinct shortage of available labour will manifest itself in buoyant wage growth.
Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3 and later also in the following two years.
At its August monetary policy meeting, the Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being slightly inflationary. At the close of the meeting, the Bank Board decided unanimously to increase the two-week repo rate to 0.25%. The Board stated that the timing of further steps in raising interest rates would be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna.

At its meeting on 10 August 2017, 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.

Inflation declined slightly to 2.2% in 2017 Q2. According to the forecast, inflation will stay in the upper half of the tolerance band around the CNB’s target in the second half of this year. Inflation pressures are currently peaking, reflecting accelerating growth in wages and economic activity. Growth in domestic costs will slow in the period ahead due to rising labour productivity growth, which will increasingly offset the impact of faster growth in wages and economic activity. The current already only slightly inflationary effect of import prices will quickly turn anti-inflationary. This will reflect subdued foreign producer price inflation and a strengthening koruna. Inflation will thus decrease towards the CNB’s 2% target in early 2018 and will be slightly below it over the monetary policy horizon. Core inflation will meanwhile fluctuate stably around 2%.

The growth of the Czech economy will accelerate visibly above 3% this year. It will stay slightly above this level in the following two years. The economy will thus remain slightly above its potential output level. Growth in domestic economic activity will be driven mainly by robust growth in household consumption, reflecting optimism of consumers in an environment of fast growth in their income and low interest rates. Investment will recover, especially in the government sector as a result of higher drawdown of EU funds. The economy will benefit from continued demand growth in the Czech Republic’s main trading partner countries. However, its favourable effect on net exports will be gradually outweighed by rising domestic demand and a stronger exchange rate. Stable growth in labour demand coupled with an increasingly distinct shortage of available labour will manifest itself in robust wage growth.

Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3 and later also in the following two years. However, the return of interest rates to their long-run neutral level will be strongly hampered until around mid-2018 by the ECB’s ongoing quantitative easing, which is putting appreciation pressure on the koruna.

At its August monetary policy meeting, the Bank Board assessed the risks to the inflation forecast at the monetary policy horizon as being slightly inflationary. This is because the exchange rate may be weaker than forecasted in the quarters ahead owing to the closing of koruna positions by financial investors amid the absence of a counterparty. At the close of the meeting, the Bank Board decided unanimously to increase the two-week repo rate to 0.25%. The Lombard rate was increased to 0.50%. The discount rate was left unchanged at 0.05%. The Board stated that the timing of further steps in raising interest rates would be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna.

Marek Zeman
Director, CNB Communications Division