Statement of the Bank Board for the press conference following the monetary policy meeting
At its meeting today, the Bank Board of the Czech National Bank increased the two-week repo rate to 3.75%, i.e. by one percentage point. At the same time, it increased the discount rate and the Lombard rate by the same amount to 2.75% and 4.75% respectively. Five members voted in favour of this decision and two members voted for leaving rates unchanged.
This decision of the Bank Board is underpinned by the autumn macroeconomic forecast and by an assessment of information obtained since it was prepared. Consistent with the autumn forecast is a sharp rise in market interest rates at the end of this year and the start of 2022 in response to the exceptionally strong price pressures from the domestic and foreign economies. Only a part of the forecasted rise in interest rates was delivered by the Bank Board’s November decision. At its meeting today, moreover, the Bank Board assessed the risks and uncertainties of the autumn forecast as being markedly inflationary overall and hence requiring faster monetary policy tightening compared with the current forecast.
The outlook for foreign industrial producer price inflation this year and the next has been revised markedly upwards. This is due mainly to a sharp rise in prices of energy commodities, i.e. natural gas, coal and electricity, coupled with persisting disruptions to material and component supplies. However, the outlook for higher growth in foreign producer prices is also driven by strong demand. For similar reasons, consumer price inflation in the euro area has been revised slightly upwards as well. Higher expected economic growth in the euro area this year and the next mainly reflects a stronger summer recovery of economies following their reopening. The outlook for industry at the close of this year has also improved. The foreign interest rate projection is almost unchanged.
The Brent crude oil price has corrected the rise it recorded in late October. Overall, its outlook has changed only slightly by comparison with the assumptions of the current forecast, having decreased somewhat for next year. The expected euro-dollar exchange rate is marginally weaker over the entire forecast horizon.
Domestic inflation has risen further so far in Q4, reaching 6% in November 2021. It is thus well above the upper boundary of the tolerance band around the Czech National Bank’s 2% target. In November, annual consumer price inflation was about one percentage point above the forecast. This deviation was due mainly to sharply accelerating core inflation.
However, faster growth in administered prices and higher fuel prices also acted in the same direction. Food price inflation went up as well, though more slowly than forecasted. The higher overall domestic consumer price inflation reflected faster growth in foreign industrial producer prices coupled with the exchange rate of the koruna, which was weaker than forecasted. Higher growth in housing-related energy prices and in the cost of owner-occupied housing for Czech households also played a role. The inflation developments up to now suggest unexpectedly strong inflation pressures from the domestic and foreign economies. According to the autumn forecast, headline inflation will rise further from its current high levels in the winter months and will be well above the upper boundary of the tolerance band around the inflation target in the next few quarters. However, inflation will start to ease in the course of next year and will decrease close to the 2% target over the monetary policy horizon, i.e. in late 2022 and early 2023, aided by a continued significant tightening of the monetary conditions.
The Czech economy continued to grow in Q3. The recovery was stronger by comparison with the current forecast. This was due mainly to household consumption, which was supported by higher-than-forecasted wage growth. Spending of savings seems to have been stronger as well. Growth in government consumption was also above the forecast. As expected, the economic recovery was also fostered by gross capital formation. However, its double-digit growth primarily reflected an accelerating contribution of change in inventories. By contrast, GDP growth was dampened by a drop in net exports due to worse export performance of the Czech economy, which reflected forced cutbacks in industrial production owing to problems in global production and supply chains. According to the current forecast, the Czech economy will grow by around 2% overall this year and gain pace considerably over the next two years. Economic activity will return to the pre-pandemic level at the end of 2022.
At the beginning of the autumn, industry was still being hampered by bottlenecks in global supply chains. In particular, the automotive industry and related sectors were suffering from shortages of material. Industrial production thus recorded a year-on-year decline in September and October. By contrast, retail sales excluding the automotive segment rose at a solid pace in October, signalling a continued recovery in household consumption in 2021 Q4. Growth in construction output increased further in October.
The tightness in the labour market is increasing rather more markedly than expected by the autumn forecast. Employment started rising in Q3. The share of unemployed persons has been falling in line with the forecast in recent months, but the decline in the general unemployment rate has been slightly faster than forecasted. Many firms are facing labour shortages. Year-on-year wage growth in the market sector slowed sharply in Q3 due to base effects but was clearly above the forecast.
The koruna-euro exchange rate has been weaker than forecasted so far during Q4. After the Czech National Bank increased interest rates in November, the koruna appreciated to CZK 25.20 to the euro. However, it then weakened temporarily due to negative financial market sentiment resulting from a deterioration in the epidemic situation and the emergence of the new Omicron variant of the coronavirus. A sizeable widening of the positive interest rate differential vis-à-vis the euro area probably dampened the impact of the negative sentiment on the exchange rate. According to the current forecast, the Czech currency will firm gradually to CZK 24 to the euro over the next year.
To sum up the materialisation of the autumn forecast, economic growth and average wage growth were roughly one percentage point above expectations in Q3, as was inflation in November. The share of unemployed persons was as forecasted in the autumn months. At the same time, we can already state now that our next (winter) forecast will contain a sizeable increase in the inflation outlook, especially in the short run.
The Bank Board assessed the risks and uncertainties of the autumn forecast as being markedly inflationary overall and hence requiring faster monetary policy tightening compared with the current forecast. In particular, the threat of weaker anchoring of inflation expectations in an environment of a long-running marked overshooting of the Czech National Bank’s 2% target poses a substantial risk. Possible faster and longer-lasting growth in industrial producer prices abroad is a risk in the same direction. A potential weakening of the response of the exchange rate of the koruna to growth in domestic interest rates is another inflationary risk.
In this situation, the Bank Board, after carefully considering all the aspects, decided to increase interest rates significantly further. This will support the return of inflation towards the Czech National Bank’s 2% target over the monetary policy horizon. The inflation expectations of firms and households have been faced with a marked overshooting of the 2% target for some time now, and the Czech National Bank does not intend to allow them to become more significantly unanchored from the target. The Bank Board is therefore ready to continue increasing interest rates next year in order to maintain price stability in the Czech Republic.