CNB issues Inflation Report IV/2011

• The new macroeconomic forecast expects headline inflation to rise temporarily to just below 3% in 2012 owing to a VAT increase and fall back below the 2% target at the start of 2013.
• Monetary-policy relevant inflation will be slightly below the target over the entire forecast horizon.
• Economic growth will slow further in the remainder of the year owing mainly to fading investment in inventories, to continuing fiscal consolidation and also to weakening external demand, whose continued contraction will then lead to a further slowdown in GDP growth in 2012.
• The forecast expects the nominal koruna-euro exchange rate to appreciate from the start of 2012 onwards.
• Consistent with the forecast is a slight decline in market interest rates at the start of the forecast and flat rates until late 2012/early 2013.
• In addition to the baseline scenario, an alternative scenario entitled “euro area stagnation” was drawn up, taking into account the risks related to the assumptions of future economic developments abroad.

At its meeting on 10 November 2011, the Bank Board of the Czech National Bank approved this year’s fourth 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, which 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 described in section II of the Report expects headline annual inflation to rise temporarily to just below 3% in 2012 owing to VAT changes. The second-round effects of the VAT increase are not expected to be significant. After the first-round effect of the VAT change has subsided, headline inflation will fall below the 2% inflation target in 2013. Monetary-policy relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will be slightly below the target over the entire forecast horizon.

Economic growth will continue to slow in the second half of this year owing mainly to fading investment in inventories, to continuing fiscal consolidation and to slowing external demand. In 2011 as a whole, GDP will increase by 2%. The impact of the continued contraction in external demand on GDP growth will be clearly visible in 2012, when annual GDP growth will slow to 1.2%. Real economic activity will strengthen again in 2013 (to 2.7%) owing to a recovery of economic growth in the euro area and a moderation of the impacts of fiscal consolidation. The aforementioned evolution of economic activity will be reflected on the labour market in subdued growth in total employment this year and stagnation in 2012. Employment will start rising slightly in 2013. This will be reflected in a decline in the unemployment rate. Wage growth in the business sector will accelerate gradually and wages in the non-business sector will also start rising in 2012. The nominal koruna-euro exchange rate will begin to appreciate at the start of 2012 from a temporarily weaker level at the end of this year. Consistent with the forecast is a slight decline in market interest rates at the start of the forecast and flat rates until late 2012/early 2013. Interest rates do not react to the expected temporary rise in inflation above the target caused by the first-round effects of the changes to indirect taxes.

In addition to the baseline scenario, an alternative scenario entitled “euro area stagnation” was drawn up, capturing the risks related to the assumptions regarding future economic developments abroad. The adverse trends associated with the escalation of the global debt crisis are being incorporated into expectations of economic activity and inflation in the euro area only gradually, whereas the market outlook for interest rates has been responding strongly and immediately. This alternative scenario thus describes a marked GDP growth slowdown in the euro area in 2012 to almost zero on average, together with a faster fall in inflation. The aforementioned developments abroad lead to a more significant cooling of domestic economic activity and a weaker exchange rate of the koruna. A more pronounced depreciation of the koruna is prevented by higher 3M PRIBOR rates compared to the baseline scenario. Headline and monetary-policy relevant inflation is little different from the forecast, as the effect of weaker economic activity, lower wage growth and lower administered prices is offset by much slower appreciation of the koruna.

• Full text of the Inflation Report (pdf, 4,7 MB)
• Key macroeconomic indicators (xls, 80 kB)
• Tables and charts from the Inflation Report (xls)
• Current CNB forecast

Marek Petruš, CNB spokesman