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 5.00%, i.e. by 0.50 percentage point. At the same time, it increased the discount rate to 4.00% and the Lombard rate to 6.00%. Five members voted in favour of this decision and two members voted for leaving rates unchanged.
The decision of the Bank Board is underpinned by an assessment of the currently available information, which largely relates to the economic impacts of the war in Ukraine. The war has significantly changed the outlooks for the foreign and domestic variables included in the winter forecast. Consistent with the winter forecast was a substantial rise in market interest rates, followed by a gradual decline from the second half of this year onwards. In light of the new information, the Bank Board at its meeting today assessed the risks and uncertainties of the winter forecast as being markedly inflationary, especially in the short run. These risks also require significantly tighter monetary policy, and probably for longer than predicted by the winter forecast.
The European economy, which was recovering from the coronavirus pandemic in early 2022, will be adversely affected by the military conflict in Ukraine. The conflict, coupled with the sanctions against Russia, has caused a sharp rise in energy, industrial and food commodity prices. It will also lead to longer-lasting problems with material and component supplies. Expected foreign industrial producer price inflation has thus shifted significantly upwards, especially for this year. For similar reasons, consumer price inflation in the euro area has also been revised upwards, albeit to a lesser extent. The expected negative effects of the war in Ukraine have also fostered a decrease in the outlook for economic activity in the effective euro area this year and the next. The prediction for foreign interest rates has moved upwards, especially for next year.
The Brent crude oil price has been rising due to limited production since the start of this year. Its growth accelerated further after Russia’s invasion of Ukraine. The oil price outlook has thus increased substantially compared with the assumptions of the current forecast. At the same time, the euro has weakened slightly against the dollar, and so has its outlook.
Domestic inflation increased markedly further in the first two months of this year, i.e. before the outbreak of war in Ukraine, and exceeded 11% in February. It was thus well above the forecast. This was due mainly to a surprisingly sharp rise in food price inflation, reflecting unusually high prices of world agricultural commodity prices together with unexpectedly strong growth in domestic agricultural producer prices. The war in Ukraine, which is one of the world’s leading exporters of wheat, is generating additional price pressures in the food segment. The deviation of inflation from the forecast was also due to markedly higher growth in administered prices (especially energy prices) and fuel prices. Core inflation was broadly in line with the forecast. The inflation developments up to now suggest unexpectedly strong inflation pressures from the domestic and foreign economies, which are being exacerbated by the price shock due to the war. The winter forecast expected inflation to peak in the first half of this year and then moderate gradually, decreasing close to the 2% target over the monetary policy horizon, i.e. by mid-2023. According to the current estimate, however, headline inflation will rise further in the coming months of spring and remain very high for the rest of this year.
GDP growth was in line with the forecast at the close of last year. As regards its structure, higher-than-expected additions to inventories were broadly offset by lower other expenditure items, household consumption in particular. The winter forecast expected the Czech economy to grow by about 3% this year and accelerate slightly further next year. According to our preliminary estimates, the outbreak of war in Ukraine will reduce expected economic growth to about one-half of that figure this year. Besides more subdued exports, the drop in external demand will be reflected in lower corporate investment activity in the domestic economy. Additional problems with supplies of some components and materials will aggravate the already significant supply-side constraints and have a sizeable impact on the domestic automotive industry in particular. In addition, further growth in energy prices and headline inflation is likely to weigh on household consumption this year.
Industry continued to face problems at the start of the year. Corporations are suffering from strongly rising input prices. Nevertheless, growth in industrial production excluding the automotive industry was solid in January. Construction output rose again in January, as did retail sales excluding the automotive segment, which were up 10% following a downturn in December.
The tightness on the domestic labour market is still increasing slightly. While the share of unemployed persons decreased in line with the forecast in January and February, the general unemployment rate fell somewhat faster than forecasted in 2021 Q4. Many firms continued to face labour shortages. Nonetheless, annual wage growth in the market sector slowed further in 2021 Q4 and was slightly below the forecast.
The winter forecast expected the koruna to appreciate initially and then stabilise just below CZK 24 to the euro. In Q1, the koruna-euro exchange rate was slightly weaker on average compared with the winter forecast. The outbreak of war in Ukraine led to excessive exchange rate fluctuations and rapid depreciation of the koruna. The Czech National Bank reacted by intervening in the foreign exchange market in early March. Coupled with a calming of the financial market situation in recent weeks, this has led the koruna to appreciate. The CNB has not needed to intervene in the foreign exchange market for a while now. The CNB is therefore resuming its activities under the programme of sales of part of the income on international reserves, which was suspended while its foreign exchange market interventions were going on. In the managed float exchange rate regime, the CNB remains ready to react at any time to excessive koruna exchange rate fluctuations that would disrupt the smooth functioning of the foreign exchange or financial market or that would jeopardise price stability and financial stability in the Czech Republic. The CNB has sufficient international reserves to fulfil its monetary policy objectives and other duties.
To sum up the materialisation of the winter forecast, inflation was 1.3 percentage points above the forecast in February. By contrast, the average wage in 2021 Q4 was 0.6 percentage point lower. Economic growth in the final quarter of last year and the share of unemployed persons so far in 2022 Q1 were in line with the forecast.
The Bank Board assessed the risks and uncertainties of the winter forecast as being markedly inflationary, especially in the short run. This requires significantly tighter monetary policy compared with the current forecast, and probably for a longer period of time. The higher domestic and foreign inflation in the year to date and sharp growth in energy and commodity prices due to the war in Ukraine are inflationary risks, especially this year. Weaker anchoring of inflation expectations to the CNB’s 2% target remains a risk in the same direction. Less restrictive fiscal policy related to the refugee crisis is also an upside risk to inflation this year. By contrast, worse future economic developments having an impact on the labour market and related lower demand-driven inflation are an anti-inflationary risk.
In this situation, the Bank Board, after carefully considering all the aspects, decided to increase interest rates further. This is in response to a further marked increase in inflation pressures in the Czech economy. For the time being, the CNB has decided to partially disregard the direct impacts of the war in Ukraine on consumer prices. However, monetary policy is reacting and will react to the indirect price effects of these pressures, ensuring that inflation returns to the 2% target in the longer run. The Bank Board is closely monitoring the current situation and is ready to continue raising interest rates so that inflation expectations do not diverge from the CNB’s 2% inflation target in the longer term. Restoring price stability soon is now the CNB’s absolute priority, because this is a necessary condition for long-term prosperity of the Czech economy. The CNB’s future monetary policy steps will depend on incoming new information and future forecasts.