Sean Carney (Dow Jones Newswires)
PRAGUE, 22 May 2009 (Dow Jones) -The Czech central bank's key interest rate is at its lowest-ever level, yet the severity of the economic downturn means the bank has room to cut rates further, a member of the central bank's monetary policy board said Friday.
"Interest rates will either be stable or decrease this year," Robert Holman told Dow Jones Newswires in an interview. The bank cut its benchmark two-week repurchase agreement rate to 1.5% on May 7.
"There is still space for cutting rates as we're 50 basis points above the European Central Bank's rate" of 1%, he said, adding that recession can bring additional disinflationary pressures.
Holman is the fourth member of the central bank's seven-strong policy board to say openly interest rates can go lower.
Some analysts are expecting a 25-basis-point cut at the bank's next policy meeting on June 25, which would bring the headline rate to 1.25%.
Pressure to cut rates intensified last week when Czech first-quarter gross domestic product data showed an annual contraction of 3.4%, the largest on record. The market expected a 2.4% annual fall in GDP, according to a Dow Jones Newswires poll.
"I was a little surprised by the depth of the contraction," Holman said, adding that he expected a drop of about 2.5%.
He said the first-quarter data is likely to be the worst of this year and the rate of contraction should narrow later in the year, leading to a full-year fall of 2.5%. Next year, he expects the country to move back to economic expansion.
To be sure, the period of low interest rates won't last, as inflationary pressures are already worrying the central banker.
"I don't believe rates can stay on a low level for a long time. It's not a sustainable level, low rates are (just) a sign of recession," he said.
Holman said the rising fiscal deficit, as the government increases spending amid a period of falling tax revenue, is a danger to economic progress that will push up long-term interest rates and create inflationary pressure.
"It's not good for the economy, monetary policy can't impact long-term rates, but can only influence the real economy by influencing the exchange rate," he said.
"Loose fiscal policy will force the central bank to raise interest rates," Holman said.
However, the central bank has a somewhat easier job recently as the koruna's volatility has largely vanished.
"We're glad the koruna has stabilized between 26 and 27 (to the euro) and that it didn't depreciate further. It was our main concern at the end of last year," Holman said.
The currency firmed to a record level of 23 to the euro last summer and then sharply depreciated to near 30 to the euro early this year, amid fears that an economic meltdown in Central European would cause currencies and governments to collapse.
That fear was calmed when the International Monetary Fund stepped in to support needy states in the region, including Hungary and Ukraine but not the Czech Republic, which is a net donor to the IMF.