MONETARY POLICY REPORT | WINTER 2025 (box 2)
(authors: Tatiana Keseliová, Tomáš Pokorný, Jan Syrovátka, Tomáš Šestořád)
The CNB’s price stability mandate involves retrospectively assessing the fulfilment of its 2% inflation target and determining the causes of any past deviations of inflation from the target. This box, regularly included in the report, contains the assessment for the last two calendar years, i.e. for 2023 and 2024.
In the course of 2023, consumer price inflation visibly slowed from initial double figures. In spite of that, it was well above the CNB’s 2% inflation target throughout the year. Inflation fell to the target at the start of 2024 (see Chart 1) and stayed close to it for the rest of 2024. Price stability, which had been disrupted by previous extraordinary events (in particular the pandemic and the energy crisis), was thus successfully restored. This box uses the g3+ core forecasting model[1] to determine the key factors underlying the deviation of inflation from the CNB’s inflation target (see Chart 2).
The monetary policy rule in the g3+ model sets interest rates so as to ensure that inflation returns to the 2% target at the monetary policy horizon. The inflation outlook takes on board the forecasts for all relevant macroeconomic variables. The emphasis on the monetary policy horizon reflects the gradual transmission of interest rates to future economic developments and in turn to inflation. By concentrating on inflation at this horizon, the central bank simultaneously abstracts from short-term inflation shocks. Their impact can be controlled by monetary policy to only a minimal extent. In addition, any efforts to mitigate them quickly would cause excessive interest rate volatility, which would destabilise the economy. The monetary policy rule also includes interest rate smoothing by the central bank. Nonetheless, active monetary policy stabilises inflation at the target in the medium term. This is usually accompanied by gradual movement of interest rates towards their neutral long-run level (3%).
Chart 1 – Inflation returned to the CNB’s target at the start of last year
consumer prices in %
Chart 2 – The overshooting of the target in 2023 was due mainly to a sharp rise in energy prices and to retailers’ elevated profit margins; in 2024, the deviation from the target was minimised
deviation of monetary policy-relevant inflation from CNB’s 2% target; contributions in pp
Monetary-policy relevant inflation is inflation to which monetary policy reacts in the forecast. It is defined as headline inflation adjusted for the first-round effects of changes to indirect taxes.
The initial significantly positive contribution of foreign prices shrank during 2023 as the inflationary impacts of the disruption to global value chains and the huge rise in energy commodity prices on global markets exacerbated by Russia’s aggression in Ukraine subsided. Foreign industrial producer prices underwent a minor correction during the two years assessed in the box. The growth in domestic retailers’ highly elevated costs thus also gradually slowed, creating room for inflation to decrease to the target.[2]
The increase in energy prices also strongly affected administered prices. Their contribution to the deviation of inflation from the target was thus also positive in 2023. Conversely, the decrease in the commodity component of electricity prices in 2024 did not have a large impact on retail prices, due to an increase in the administered component of energy prices in January 2024. As a result, the contribution of administered prices was neutral overall last year.
The domestic economy had a strong inflationary effect in the past two years, although the intensity of this effect decreased gradually. In 2023, retailers raised their prices by more than what the growth in their costs implied. Firms’ profit margins were thus distinctly elevated.[3] Although the profitability of sellers of goods and services started to decline last year due to the tight monetary policy in 2023, estimated margins stayed above their usual levels.
The ECB responded later and less forcefully than the CNB to the surge in price pressures in the euro area resulting from the energy crisis and the problems in value chains. The positive interest rate differential thus exerted appreciation pressure on the koruna throughout 2023, hence slowing domestic inflation. However, this effect faded over time as the ECB continued to increase its rates, while the domestic 3M PRIBOR market rate was already gradually decreasing owing to the expected start of the CNB monetary policy rate-cutting cycle. This occurred in December 2023 and the reduction of domestic interest rates continued almost throughout 2024, while the ECB did not start the process of cutting its policy rates until mid-2024. Last year, therefore, a narrowing interest rate differential conversely put depreciation pressure on the koruna and thus upward pressure on consumer prices.
The koruna exchange rate had a roughly neutral effect in 2023. In 2024, its contribution to the deviation of inflation from the target was slightly positive, as the koruna weakened slightly more year on year than implied by the narrowing interest rate differential vis-à-vis euro rates.
In 2023, the Bank Board assessed the risks and uncertainties of the forecasts at the time initially as significant and going in both directions, and in the second half of the year as inflationary. Most of the previously identified risks persisted, in particular weaker anchoring of inflation expectations in an environment of long-running overshooting of the inflation target, which could have given rise to a wage-price spiral, and more expansionary domestic fiscal policy (measures aimed at mitigating the impacts of the energy and refugee crises). Therefore, the Bank Board communicated that the interest rate path would be higher than in the baseline scenario of the forecast. The uncertainties continued to include the future course of the war in Ukraine, the availability and prices of energy, and the future monetary policy stance abroad. In December 2023, the Bank Board started the process of cutting key interest rates (in the case of the 2W repo rate from 7%) due to a falling inflation outlook, stating that it considered it necessary to persist with tight monetary policy and approach potential further rate cuts with caution.
In 2024, the Bank Board continued to assess the risks of the forecasts mostly as slightly inflationary. The main upside risks identified were a slower decline in the elevated inflation expectations, higher-than-expected inertia in services inflation, increased wage demands in the private and public sector, potential excessive growth in total public sector spending and a potential acceleration of money creation in the economy stemming from a significant recovery in lending activity, especially on the property market. By contrast, a downturn in global economic activity and weaker German – and hence Czech – economic output were assessed as a downside risk. The future monetary policy stance abroad was an uncertainty. The Bank Board continued to emphasise the need for tight monetary policy until the disinflation process was completed. This implied a cautious approach to reducing interest rates. The CNB lowered interest rates gradually (in steps of 0.25–0.5 pp) at each monetary policy meeting until November 2024, when the 2W repo rate reached 4%.
Inflation was well above the 2% inflation target in 2023 and later returned to the target. From this perspective, it can be said with the benefit of hindsight – with knowledge of the exceptional events that occurred – that monetary policy should have been much tighter in the relevant period to mitigate the strong inflation pressures. This is especially true for the second half of 2021, although the underlying inflationary environment in the economy was also due in part to accommodative monetary policy before and during the Covid pandemic. The subsequent higher-for-longer rates meant that monetary policy started to have a restrictive effect last year and thus largely offset the persisting inflation pressures stemming mainly from the domestic economy.
[1] The g3+ core prediction model is used to prepare the CNB’s macroeconomic forecasts. It is also employed to assess the fulfilment of previous forecasts and to determine the sources of deviations of the actual figures from the forecasts under assessment and the inflation target. For details, see The g3+ model: an upgrade of the Czech National Bank’s core forecasting framework, CNB WP 7/2020.
[2] The decrease in corporate costs due to the partial correction of market energy prices was dampened by an increase in the administered component of energy prices.
[3] A deterioration in whole-economy labour productivity also played a role in the inflationary effect of the domestic economy in 2023. Despite the economic downturn, employment grew visibly, increasing corporate costs.