By Sean Carney (Dow Jones 17.5.2011)
- Czech monetary tightening likely before year end
- Euro-zone crisis biggest risk to Czech economic outlook
- Adoption of euro losing its attractiveness for Czechs
- Strong koruna offsets inflationary pressures
- Greek bond restructuring needed to reassure markets
A growing Czech economy means monetary policy will be tightened this year, but the euro zone's fiscal crisis and its lack of appropriate rules cast a shadow over the country's economic outlook, the newest member of the Czech central bank board said Tuesday.
"The current risk is really associated with fiscal issues in the euro-zone," Lubomir Lizal told Dow Jones Newswires in his first interview since taking a position on the Czech central bank's monetary policy board in February.
The Czech economy derives roughly 70% of gross domestic product from exports, particularly Germany, so external events have a direct impact on the economy. But with markets widely expecting Greece to default on or at least be forced to restructure its debt while euro-zone leaders cast about for temporary solutions, the Czech economic outlook is muddled.
"This is something which creates a highly uncertain environment and that's why I feel we should be cautious in the respect that the alternative [more pessimistic] scenarios [in the central bank's forecasts] might have some real impact," Lizal said.
In the two monetary policy meetings that Lizal has participated in, he voted to keep the central bank's key interest rate unchanged at 0.75% to err on the side of caution.
But Tuesday the former academic, who has degrees in both electrical engineering and economics, said that monetary policy can't remain at this historic low for long.
"The current level of interest rates is of course something that is temporary, the question is when we will see the real change in the economy, when we'd really observe real demand pressures," he said.
"In that respect, yes, there will definitely be a change in the rates...the question is how quickly those pressures will materialize and how [significant] they will be," Lizal said.
Most economists as well as the central bank's own analysts expect the first rate hike to come in the fourth quarter of this year, which Lizal agrees with. But he stopped short of indicating to what extent rates may need to be tightened.
Lizal said the German economy relies on machinery exports while the domestic service sectors lag behind, and that the Czech economy is increasingly reflecting that imbalance.
And a lack of clear economic growth in other sectors of the Czech economy is a key reason to go slowly with policy tightening, he said.
Even though policy rates have been at historic lows for a year now, the koruna is still trading near 30-month highs. Lizal said the country's industrial backbone can easily handle currency gains of between 2% and 3% to the euro annually and that such firming is actually helpful because it is disinflationary.
But a firming of 5% on the year is the threshold at which the economy would sputter, he said.
Looking forward, Czech officials really have no need to think about euro adoption because a record 75% of the population is now against switching to the common currency, he said, citing a recent poll.
"Europe probably has to make some redesign of the rules...and after that we might be looking whether the rules make sense and whether they are still interested in other countries [joining the bloc]. So i don't think this is anything in the near horizon at all."
The euro zone is "definitely" losing its appeal, largely because the bloc is using outdated accession criteria and lacks leadership in tackling its tough problems.
"I don't think the current situation with new and new guarantees for other countries is something that can last for long" and the euro zone definitely needs to redesign internal rules or else it risks crumbling, he said.
The currency bloc's current guarantees and lines of credit to troubled member states are only buying time before the euro zone comes up with a real economic solution.
A swift restructuring of debt in countries such as Greece is the answer, though it will take time to get there, he said.
"It's probably the solution that everyone is afraid of but on the other had it would send a correct signal to the market that yes, we can deal with situations that have virtually no solution, that we can take painful steps and do them right."