The Czech central bank (CNB) increased the two-week repo rate by 0.50 percentage point (pp) to 5%, CNB Governor Jiri Rusnok announced in his presentation on March 31. Five members voted in favour of this decision, two members voted for leaving rates at 4.5%.
At the same time, the bank board increased the discount rate by 0.5pp to 4% and the Lombard rate to 6%. The new interest rates come into effect on April 1, 2022.
The decision demonstrates that the CNB still sees inflation as the bigger threat to the Czech economy, despite the growing signs of stagflation, as the war in Ukraine pushes up inflation but also cuts growth.
"The current economic development is showing a stagflationary trend, which is generally an unpleasant dilemma for central banks. However, in a situation with a very low unemployment rate in the domestic economy, the CNB has decided to focus on fighting inflation for the time being, and concerns about the economy's growth have been pushed to the sidelines for now," said Jakub Seidler, chief economist at the Czech Banking Association.
According to the CNB report, the European economy, which was recovering from the coronavirus pandemic in early 2022, will be adversely affected by the war in Ukraine. The conflict itself and the sanctions against Russia led to a sharp rise in energy, industrial and food commodity prices. It is expected to result also in longer-lasting problems with material and component supplies.
The winter forecast expected the Czech economy to rise around 3% in 2021 and 2022. Nevertheless, the war in Ukraine is expected to reduce expected economic growth roughly to one-half of that figure.
“Today´s monetary policy decision is underpinned by an assessment of the currently available information, which largely relates to the war in Ukraine. The war has significantly changed the outlooks for the foreign and domestic variables included in the CNB’s winter forecast. Consistent with the winter forecast was a substantial rise in market interest rates, followed by a gradual decline from the second half of this year onwards,” the bank said.
The CNB winter forecast expected Czech inflation to peak in 1H22, followed by a drop to 2% target. However, based on the current estimate, inflation is forecast to remain at a high level for this year.
In 2M22, inflation increased before the outbreak of war in Ukraine and exceeded 11% in February, well above the forecast, driven mainly by a sharp rise in food and energy prices. Now the war in Ukraine, which is one of the world’s leading exporters of wheat, is generating additional price pressures in the food sector.
“This may mark the end of the cycle, but the worsening inflation outlook means that there is a risk of further interest rate hikes in the coming months,” commented Joseph Marlow, Assistant Emerging Europe Economist at UK forecaster Capital Economics.
“Inflation pressures continue to run hot in Czechia, with the headline inflation rate hitting a fresh 20-year high of 11.1% y/y in February and core inflation soaring to 10.4% y/y. The war in Ukraine will add to inflationary pressures over the next few months by pushing up energy costs and causing supply disruptions, and we think that headline inflation could reach around 13% by the middle of the year,” Marlow noted.
“For now, we suspect that today’s 50bp increase will mark the end of the tightening cycle, but we will be watching the press conference closely to assess whether the CNB has become more concerned with the inflation outlook and feels the need to continue tightening,” Marlow said.