By Radoslav Tomek and Lenka Ponikelska (Bloomberg 16.9.2009)
A widening Czech budget deficit may prompt the central bank to raise interest rates even as the economy emerges from recession, policy maker Pavel Rezabek said.
The budget outlook “will certainly make me more reluctant to keep interest rates low,” Rezabek said in an interview in Prague yesterday. “If the macroeconomic position deteriorates, low rates would present a more significant risk.”
The country is heading for a record budget deficit of 7.4 percent of gross domestic product this year after the recession caused tax revenue to wane. A weak interim government that’s ruled for six months and a failure by lawmakers to agree on a spending overhaul may entail a similar shortfall in 2010.
“High budget deficits may negatively influence the Czech Republic’s credibility and this can trigger an increase in nominal interest rates, which I don’t want, and that’s why I am sending stronger and stronger warnings,” Rezabek said.
The central bank on Aug. 6 cut its two-week repurchase rate to a record low 1.25 percent, citing slack inflation pressures.
The move brought the combined reduction in borrowing costs since June 2008 to 2.25 percentage points.
Lawmakers yesterday failed to dissolve Parliament to allow early elections. With an interim government in place, and the constitutional court ruling against an early ballot, the present Cabinet will have difficulty adopting structural changes to cut spending before a vote now set for June, analysts say.
‘Too Optimistic’
The Czech economy contracted in the fourth quarter of 2008 and the first three months of this year, pushing unemployment to the highest since 2006 and widening the deficit as tax revenue fell. The economy emerged from recession in the second quarter, growing 0.3 percent, although economists say it may take months before growth fully revives.
Rezabek said it’s “too optimistic” to think that the recession in western Europe, the Czech Republic’s key trading partner, is ending and it remains to be seen which part of the economic cycle the region is in. A W-shaped recovery rather than a V-shaped recovery can’t be ruled out in Europe, he said.
The French and German economies have emerged from recession, GDP reports for the second quarter show. The European Commission said yesterday it expects the euro region to post quarterly growth from the third quarter, after contracting 0.1 percent in the three months ended June.
Koruna Strength
A strengthening of the Czech koruna isn’t hindering a recovery, Rezabek said. A nominal appreciation of about 3 percent a year “is natural and should be absorbed by the economy,” he said.
The currency closed at 25.385 against the euro yesterday, and has gained almost 6 percent in the past three months, while still more than 5 percent weaker than a year ago.
With the key rate at a record low, a further reduction would have a limited impact on commercial lending rates, Rezabek said, without ruling out a cut should economic reports show the recession is deepening.
“I don’t think a further reduction in interest rates would significantly contribute to a recovery,” Rezabek said. “The stability of the economic environment would have a bigger impact and this can be reached through fiscal” policy.
Keeping ‘Ammunition’
“If there’s a slight contraction, I personally won’t feel obliged to react,” he said. “We should keep the ammunition.”
Policymakers are scheduled to discuss interest rates on Sept. 24. All seven economists surveyed by Bloomberg expect borrowing costs will be kept on hold.
Financial markets have already priced in an increase in interest rates next year, forward-rate agreements show.
Investors willing to lock in borrowing costs for a three- month period starting in nine months from now would pay an interest rate of about 2.3 percent, about 0.5 percentage point above the current three-month interbank rate.
Rezabek said he isn’t concerned about inflation in the foreseeable future as rising unemployment will keep demand pressures in check. On the other hand, lowering rates now may boost price growth after economic output resumes, he said.