By Margit Feher and Veronika Gulyas (28.5.2011)
BUDAPEST (Dow Jones)--The Czech central bank is weighing raising interest rates as it is seeing signs of demand-side pressure on inflation emerging due to an anticipated pickup in domestic demand, Miroslav Singer, governor of the central bank, or CNB, told Dow Jones Newswires.
Economic developments since the last rate meeting, however, justify a neutral stance for now.
"I see no dramatic change since the last decision, there is some deviation from the scenario--the exchange rate is a bit possibly weaker and the euro-zone debt crisis is escalating, which is a major anti-inflationary risk, but these are roughly balanced," Singer said in an interview Friday afternoon.
The Czech central bank has kept its headline rate unchanged at a record low of 0.75% since May 2010.
"We have the lowest policy rate in Europe and we are discussing whether we are changing our mind," Singer said.
Singer said the bank expects inflation at or very close to the bank's inflation target of 2% over the monetary policy horizon. The finance ministry expects annual consumer price inflation to jump to 3.2% in 2012 from its 2.1% forecast for this year.
"We are simply trying to assess the internal, mainly demand cost inflationary pressures," Singer said.
"We may be raising [interest rates] sooner than previously forecast not due to the value-added tax effect but as there are small signals that the economy is picking up, producing demand-side pressure on inflation," Singer said.
Inflation pressures may warrant a sooner-than-anticipated interest rate rise from as early as October rather than the year-end, Singer said earlier this month.
The Czech government approved a plan this week to raise VAT next year to finance the overhaul of the state-run pension system. Parliament needs to approve the VAT increase.
"The VAT increase will not produce any dramatic secondary effect on inflation expectations, the CNB already has VAT [increase present] in its thinking as an alternative scenario," Singer said.
The Czech economy is driven by exports, mainly to Germany but domestic demand has been in the doldrums. Stock-building seems to have taken place quite extensively and now the central bank is looking for signs of increased investment activity, Singer said. The central bank also expects domestic demand to pick up, Singer added.
"Growth should pick up in 2012," he said.
Singer dismissed that the European Central Bank raising interest rates as a consideration for the Czech central bank because of the rate differential.
"I think there's too much fixation on the ECB's rates. We are not especially concerned with the ECB [rates], but we are factoring it in [nevertheless]," Singer said.
"The ECB rates are telling us what the ECB thinks about the euro zone," he added.
Due to its sound economic fundamentals, the Czech Republic might see credit rating upgrades.
"Based on the latest ratings agency statements, potential upgrades can be associated with reforms related to fiscal policy. So as soon as parliament moves on these things, I'd more expect credit rating improvement but I wouldn't be disappointed or surprised if nothing happens," Singer said.
The right-of-center Czech government, which won 2010 general elections on promises to tackle the country's rising public debt, will step up its austerity efforts beyond 2012. The budget gap is seen dropping to 3.5% of gross domestic product next year and 2.9%, below of the 3% European Union Maastricht criteria, in 2012.
"The CNB is simply happy that the deficit problem has been addressed," Singer said.
As for the problems of Greece, an unavoidable issue in Europe these days, chances of a direct contagion are small, Singer said.
"How much can we get more scared by Greece?" Singer said.
"The Greek debt problem is formidable, it's a problem of competitiveness and all solutions are going to be painful," he added.
To a question whether Greece should be allowed to default on its sovereign debt or even leave the euro zone, Singer said:
"Sometimes an unhappy ending is better than unhappiness without end."