By Peter Laca (Bloomberg, 7 September 2011)
A further escalation of the euro- area’s sovereign debt crisis may delay an increase in Czech interest rates from a record low, central bank board member Lubomir Lizal said.
Policy makers in Prague are debating when to increase the benchmark two-week repurchase rate from 0.75 percent for the first time since 2008 after monetary authorities across Europe tightened credit to tame inflationary pressures this year. The European Central Bank last raised its main rate to 1.5 percent in July, pushing the difference from the Czech rate to the widest in three years.
An economic slowdown in the euro-area, the main market for Czech exports, and the outlook for lower borrowing costs in the currency union than previously expected have already postponed a rise in Czech borrowing costs this year, Lizal, 42, said in an interview yesterday.
“From the current perspective, barring further escalation of the debt problems in the euro area, the timing for increasing interest rates is around the end of the year,” Lizal said. “But the situation may change and I don’t see this is as something definitely set.”
The Ceska Narodni Banka board members have expressed differing views on inflation risks, with two policy makers demanding a quarter-point increase at the last three monetary meetings. Lizal has voted for no change since he joined the seven-member bank board on Feb. 13.
Alternatives
The central bank, which uses the outlook for euro-area market rates in as a variable in its forecast models, has signaled borrowing costs will rise around the end of this year or early in 2012. The timing of the policy change will be influenced by developments in European economies and on financial markets, which are difficult to forecast, said Lizal.
“It’s not possible to fully rule out any alternative as to when the increase may take place,” he said. “Early in the summer, it seemed that interest rates may be raised sooner. Then, another wave of the euro zone debt crisis came and changed the situation.”
Investors have scaled back bets on higher Czech interest rates, with forward-rate agreements locking in three-month interest rates in six months dropping to 1.134 percent as of 12:10 p.m. in Prague today, from 1.355 percent on Aug. 4, when the bank held its previous policy meeting. Forwards locking in three-month rates in nine months dropped to 1.111 percent from 1.425 percent on Aug. 4.
Export-Dependent
The Czech economic recovery is dependent on demand for its products, including Skoda Auto AS vehicles and car parts, from the European Union, which takes about 80 percent of the country’s exports. Germany alone is the market for about a third of Czech products sold abroad, while overall exports account for 70 percent of gross domestic product.
Quarterly growth in the euro region slowed to 0.2 percent in the second quarter from 0.8 percent in the first three months of 2011 as governments cut spending to rein in budget deficits. Germany’s economy, the region’s largest, almost ground to a halt.
“The latest data show that reliance of the Czech economy on exports is quite significant and domestic demand isn’t strong enough to compensate for an eventual weakening of external drivers of growth,” said Lizal.
The pace of Czech industrial output slowed to 4.4 percent in July, the weakest in 19 months, from 7.9 percent in June, the statistics office said yesterday. Retail sales fell 1.7 percent in July, after a 3.3 percent decline in the previous month.
Bucking the Trend
The Czech Republic has bucked the trend of rising interest rates in Europe in the past year. Poland has increased its benchmark rate by one percentage point to 4.5 percent since January, while policy makers in Hungary raised the main rate to 6 percent by January from 5.25 percent in November.
Domestic consumption in the Czech Republic has been curtailed by government efforts to cut the budget deficit through spending restrictions, while the unemployment rate has exceeded 8 percent for more than two years.
The Czech inflation rate dropped to 1.7 percent in July, from 1.8 percent in the previous month, staying under the central bank’s 2 percent target. The koruna has gained 2.52 percent to the euro so far this year, the most among 25 emerging-market currencies tracked by Bloomberg.
“So far domestic inflationary pressures are practically negligible,” said Lizal. “Furthermore, the koruna’s long-term appreciation tendency is helping to tame inflationary pressures coming from abroad” and is “tightening monetary conditions.”