Stagflation Risk Still Means Quick Rate Hikes for Czech Banker

Interview of Tomáš Holub, Bank Board member
By Krystof Chamonikolas and Peter Laca (Bloomberg 21. 10. 2021)

Czech interest rates should continue rising quickly as inflation threats outweigh risks related to a chip shortage paralyzing the country’s dominant car industry, according to a central bank board member.

Policy makers must act to quell a “very broad-based” surge in consumer prices that’s hurting savers and could become entrenched in the economy, Tomas Holub said in an interview on Wednesday.

After a surprise 75 basis-point rate increase in September, the biggest in 24 years, Holub favors another move exceeding the previous tradition of quarter-point hikes. Faster rate rises are needed despite risks to economic growth stemming from snarled global supply chains, he said.

“For me personally, the question is how much more than 25 basis points is needed in November,” he said. “Our worst-case scenario is no longer associated with coronavirus lockdowns but with the risk of inflation expectations getting out of control.”

The Czechs are the European Union’s front-runners in tightening as supply bottlenecks amplify domestic inflation pressures linked to a pre-pandemic labor shortage. 

Fears of runaway prices have become a top theme in the country, contributing to Prime Minister Andrej Babis’s election defeat and driving a home-buying frenzy. They are also boosting wage demands and fueling public purchases of inflation-linked bonds.

“All those are signs that people are beginning to change their attitudes and economic behavior,” Holub said.

A scenario where employers meet bigger salary expectations in the hope of passing the extra costs onto their customers could create a “fast wage-price spiral that won’t benefit anyone,” he said. “It will only devalue savings, and that’s exactly what we’re supposed to prevent.”

Market bets on rapid Czech hikes have so far failed to spur the currency gains the central bank projected. Dwindling demand for emerging-market assets linked to expected monetary tightening in the U.S. could also weigh on the koruna and boost the need for what Czech policy makers call rate normalization.

While it was rational for the central bank to be “slightly behind the curve” with monetary tightening during Covid-related uncertainties this spring and summer, now it’s time to pick up pace, according to Holub. In September, consumer inflation jumped to 4.9%, the fastest in 13 years, from a trough of 2.8% in June.

“Our September hike largely, if not completely, caught us up with the summer forecast,” he said. “Unfortunately, it is evident that the economic outlook has since shifted in a stagflationary direction.”

Holub, the central bank’s former chief economist, expects a significant cut in economic growth projections after Volkswagen AG unit Skoda Auto AS, the biggest Czech exporter, announced major production curbs due to a lack of chips. 

Still, he says a slower economic expansion won’t significantly damp demand-driven price pressures because the automotive industry may get government support and a shortage of workers will discourage job cuts.

“I don’t believe that should derail our policy normalization,” he said. “We have a clear mandate to secure price stability, and once we do that we can also support economic growth. But with inflation heading above 5%, I find it hard to argue that price stability is not at risk.”