At its meeting today, the Bank Board of the Czech National Bank decided unanimously to keep interest rates unchanged at technical zero. The Bank Board also decided to continue using the exchange rate as an additional instrument for easing the monetary conditions and confirmed the CNB’s commitment to intervene on the foreign exchange market if needed to weaken the koruna so that the exchange rate of the koruna is kept close to CZK 27 to the euro. In line with this, the Czech National Bank still stands ready to intervene automatically, i.e. without the need for an additional decision of the Bank Board, and without any time or volume limits. The asymmetric nature of this exchange rate commitment, i.e. the willingness only to intervene against appreciation of the koruna below the announced level, is unchanged.
This decision is underpinned by a new macroeconomic forecast. The forecast assumes that market interest rates will be flat at their current very low level and the koruna exchange rate will be used as a monetary policy instrument until the end of 2016. Inflation is still well below the CNB’s target of 2%. Despite an expected increase, it will remain below the target at the monetary policy horizon. According to the forecast, sustainable fulfilment of this target, which is a condition for a return to conventional monetary policy, will not occur until early 2017. A need to maintain significantly expansionary monetary conditions therefore persists. In this respect, the recent exchange rate appreciation is thus an unfavourable factor that is tightening the monetary conditions and hence postponing achievement of the inflation target.
In this situation, the Bank Board emphasised that the Czech National Bank would not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016. The exchange rate will therefore be at CZK 27 to the euro or weaker at least until mid-2016. The subsequent return to conventional monetary policy will not imply appreciation of the exchange rate at the forecast horizon to the slightly overvalued level recorded before the CNB started intervening, among other things because the weaker exchange rate of the koruna is in the meantime passing through to domestic prices and other nominal variables.
As regards the assumptions of the forecast regarding the external environment, growth in economic activity in the euro area should accelerate towards 2% this year and reach similar levels in the following two years. Industrial producer prices in the euro area are falling sharply year on year and consumer price inflation is still close to zero. At the start of this year, the European Central Bank responded to the subdued inflation by further easing monetary policy. This is reflected in the outlook for three-month Euribor rates, which is close to zero until the end of next year. Both producer and consumer prices are expected to start rising gradually thanks to the ECB’s easy monetary policy, a weakened exchange rate of the euro and an increase in the growth rate of the euro area economies. This will also be fostered by the fading effect of the fall in oil prices recorded in late 2014 and early 2015.
According to market outlooks, the price of Brent crude oil will rise slowly after decreasing in late 2014 and early 2015. This outlook has been revised downwards slightly over the entire horizon compared to the previous forecast. In addition, oil prices have fallen towards USD 50 a barrel in recent days. Koruna prices of energy will also be affected by the outlook for a gradually weakening euro-dollar exchange rate until early 2017.
Headline inflation increased in 2015 Q2. This increase was chiefly due to food prices, which returned to annual growth. The anti-inflationary effect of import prices, amplified by the recent appreciation of the koruna against the euro, will subside gradually, and import prices will be slightly inflationary in the second half of next year. The domestic economy will foster higher consumer prices over the entire forecast horizon via accelerating wage growth. However, inflation will dip temporarily as this year’s one-off effects dissipate in 2016 Q2 and Q3. Headline inflation will thus still be below the 2% target at the monetary policy horizon and will not hit the target until 2017.
Monetary policy-relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will be slightly lower than headline inflation owing to positive first-round effects of changes to indirect taxes stemming from further increases in excise duty on tobacco products. Monetary policy-relevant inflation will thus also be below the CNB’s 2% target at the monetary policy horizon, approaching the target from below in 2017.
The Czech economy expanded by 4% year on year in 2015 Q1, with all domestic demand components making positive contributions. By contrast, the contribution of net exports was negative. The output gap is thus closing gradually, but remains negative. The robust economic growth will continue. However, the forecast predicts a correction of the annual GDP growth rate in 2015 Q2 amid a modest quarter-on-quarter decline in economic activity linked with an expected fall in inventories. Accelerating external demand, low oil prices, easy domestic monetary conditions and higher government investment will lead to GDP growth of 3.8% this year. Economic growth will slow below 3% next year, reflecting the unwinding of the effect of an extraordinary increase in inventories at the start of this year as well as a fall in oil prices. A decline in government investment and the recent appreciation of the koruna-euro exchange rate will also foster an economic slowdown. According to the forecast, the economy will maintain the same rate of growth in 2017, with positive contributions from all components of domestic demand and, to a small extent, also from net exports. The rising economic activity will manifest itself in a further improvement in the labour market situation. The number of employees converted into full-time equivalents will continue to rise and unemployment will decrease further. Wage growth in the business sector will increase noticeably and wages in the non-business sector will rise at a stable rate.
The forecast assumes that market interest rates will be flat at their current very low level and the koruna exchange rate will be used as a monetary policy instrument until the end of 2016. Consistent with the forecast is an increase in market interest rates amid modest appreciation of the koruna in 2017.
Compared to the previous forecast, the predictions for headline and monetary policy-relevant inflation are higher until mid-2016 owing to higher observed inflation, a smaller decrease in administered prices expected in the near future and stronger growth of the Czech economy. By contrast, the recent appreciation of the koruna towards the level of the exchange rate commitment is having a downward effect on the inflation forecast. The appreciation is affecting the inflation outlook in the longer term as well. A lower prediction for administered prices next year is acting in the same direction. Expected inflation is thus slightly lower at the monetary policy horizon compared to the previous forecast. Stronger economic growth in 2015 Q1 and a faster labour market recovery have led to a marked upward revision of GDP growth this year. By contrast, the prediction for 2016 is slightly lower on account of the unwinding of the effect of an extraordinary increase in inventories this year and the recent appreciation of the koruna against the euro. The assumption of flat market interest rates at their current very low level and the use of the exchange rate as a monetary policy instrument until the end of 2016 is unchanged.
The Bank Board assessed the risks to the forecast as being broadly balanced at the monetary policy horizon. A modest downside risk may arise from the decline in oil prices, which recently decreased to USD 50 a barrel. The Bank Board emphasised again that the Czech National Bank would not discontinue the use of the exchange rate before the second half of 2016.”
