By Krystof Chamonikolas (Bloomberg 26. 4. 2018)
Record-low unemployment and rising salaries will eventually feed into Czech inflation, though price growth will probably remain subdued this year, according to the central bank’s chief forecaster
Known as the Phillips curve, the link between the jobs market and inflation has yet to fully materialize despite the fastest increases in wages since 2008. While a rapid economic expansion and labor shortages are already generating “inflationary pressures,” price growth will probably still trail the Czech National Bank’s February projections for most of 2018, Tomas Holub said in an interview on Wednesday.
Recent salary negotiations at some of the largest companies in the country suggest that strong wage growth will continue this year and possibly lead to “spillover effects” into 2019, Holub said. Although higher productivity offsets some of the rising personnel costs, businesses have been slow to pass on the rest of the increase to their customers, opting instead to sacrifice part of their potential profits, according to Holub.
“This can’t last forever,” he said. “Given the upward phase of the economic cycle and strong demand, why should anyone trim their profit margins by absorbing wage growth without raising prices? I think this psychological barrier, built during the crisis, has to collapse sooner or later.”
The central bank in Prague, which has been at the forefront of monetary tightening in Europe with three hikes in interest rates between last August and February, is debating the timing of further increases to cool one of the continent’s fastest- growing economies. Future policy decisions may come down to whether the Phillips curve will reassert itself. The decades- long economic theory is also used by global central banks like the U.S. Federal Reserve to understand inflation.
While a slowdown in price growth to 1.7 percent in March undermines the case for further rate increases, its effect on monetary policy is offset by a weakening in the exchange rate this month. That’s defying the monetary authority’s projections for tightening via currency appreciation.
The koruna will probably trade weaker this quarter and next than projected by the central bank in February, said Holub, whose team had finalized fresh forecasts, which rate setters will debate at a May 3 policy meeting and publish after the decision.
The central bank is normalizing monetary policy a year after scrapping its 27-per-euro limit on koruna gains imposed in 2013 to avoid deflation. While the exchange has since rallied
6.2 percent, the most among all currencies worldwide, it has actually been weakening for the past three months after the central bank pushed back its projection for the next rate hike to late this year or early in 2019.
Even as inflation could return to the goal of 2 percent this year, it’s still expected to run below that level on average, according to Holub. Such moderate price growth “may have some second-round effects” on the central bank’s assumptions over the monetary policy horizon of 12 to 18 months, he said.
“However, we believe those effects will be offset, to a roughly equal degree, by slower koruna appreciation in the second and third quarters than previously forecast,” Holub said.
“The exchange rate seems to have lost its appreciation drive.”