Statement of the Bank Board for the press conference following the monetary policy meeting
At its meeting today, the Bank Board lowered the two-week repo rate by 0.5 percentage point to 6.25%. At the same time, it lowered the discount rate by the same amount to 5.25% and the Lombard rate to 7.25%. Six members voted in favour of this decision, and one member voted for lowering rates by 0.75 percentage point.
The Bank Board assumes that inflation fell to around 3%, i.e. to the upper boundary of the tolerance band around the target, in January. The Bank Board still sees upside risks to inflation in the outlook for the years ahead. The materialisation of these risks would mean that inflation would fall significantly compared to previous years, but not close to the 2% target. Therefore, the Bank Board considers it necessary to persist with tight monetary policy and approach further rate cuts with caution. From this perspective, rates will be above the levels implied by the baseline scenario of the new macroeconomic forecast in this quarter and probably also the next quarter. Consistent with this scenario is a rapid decline in market interest rates in the course of this year.
At its meetings ahead, the Bank Board will base its decisions on an assessment of newly available data and updated forecasts. The pace of any further reduction in rates will depend mainly on an evaluation of the persistence of the disinflationary trend, the effect of fiscal policy on the economy, an analysis of the labour market situation, and the evolution of domestic and external demand. The Bank Board will also assess the transmission of rate cuts to lending activity and subsequently real economic activity. At the same time, the Bank Board states that the interest rate reduction process can be paused or terminated at any time at levels that are still restrictive if inflation does not decrease in line with the forecast.
The CNB’s tight monetary policy has slowed growth in the quantity of money in the economy created by lending to the private sector. Lending on the property market and, in turn, activity on the property market, has declined in particular. At the same time, the strong koruna has made imports cheaper, especially in the first half of 2023. Inflation thus declined markedly between autumn 2022 and December 2023: headline inflation fell from 18% to 6.9% and core inflation from 14.7% to 3.6%.
Although the CNB started lowering rates gradually in December 2023, the fight against inflation is not over. Interest rates remain significantly positive in real terms and are dampening inflation. The Bank Board confirms its determination to continue its tight monetary policy until inflation is stabilised close to the 2% target.
The cost inflation pressures from the external environment and demand pressures from the domestic economy are receding in the Czech economy. The economy rebounded at the end of 2023. According to the CZSO’s flash estimate, GDP rose by 0.2% quarter on quarter in Q4. The growth was driven by external demand and, for the first time in several quarters, household consumption.
However, domestic and external demand remain weak. They are being dampened by restrictive monetary policy, negative sentiment and still high energy prices, which are slowing growth in real household income. Domestic and, to a lesser extent, external demand are also being dampened by elevated saving due to households’ caution and attractive returns on deposits. According to our analyses, the economy is below its potential.
On the other hand, unemployment remains low and the labour market tight. However, wage growth slowed to 7.1% in Q3 and the risk of a wage-price spiral is therefore not materialising.
Our forecast assumes that annual inflation fell from 6.9% to 3% in January. The forecast expects inflation to remain in the upper half of the tolerance band until the end of the year and fall towards the 2% target next year. Average inflation is thus expected to be 2.6% in 2024 as a whole and 2% in 2025. However, core inflation is expected to be elevated this year, averaging 2.9%.
As regards GDP, the forecast expects domestic demand to return to growth this year, bolstered by a recovery in households’ real income. However, household consumption will remain below the pre-pandemic level. External demand will also remain subdued. According to the forecast, GDP will grow by 0.6% this year and accelerate to 2.4% next year.
Risks and uncertainties
The Bank Board assessed the risks of the forecast and the uncertainties of the outlook as being broadly inflationary. A slower decline in the elevated inflation expectations is a risk in this direction. Given the tight labour market, this could be reflected in higher wage demands. Higher-than-expected inertia in services prices and a halt in tradables disinflation, which has so far been due mainly to fading supply-side problems, are additional upside risks. An inflationary risk in the longer term is an acceleration of money creation in the economy stemming from excessive lending activity in the property market. The latter could lead to renewed highly positive contributions of imputed rent to core inflation. By contrast, a stronger-than-expected downturn in global economic activity and in German economic output is a downside risk to inflation. The future monetary policy stance abroad remains an uncertainty of the outlook.
The Bank Board assures the public that the CNB’s actions will be sufficient to restore price stability in accordance with its statutory mandate. In addition, the Bank Board is ready to react appropriately to any materialisation of the risks of the forecast.