Czech central bank raises key rate by 25bps to 0.5%

Czech central bank raises key rate by 25bps to 0.5%
The Czech central bank has long been the most independent and dynamic monetary authority in Central Europe.
By bne IntelliNews June 23, 2021

The Czech central bank raised its key interest rate by 25 basis points to 0.5% on June 23, a day after its Hungarian counterpart became the first central bank in the EU to raise rates since the onset of the coronavirus (COVID-19) pandemic.

The widely expected moves by the two Central European central banks will put pressure on Poland to follow, though analysts don’t expect it to start tightening until at least the second half of next year. It kept its reference rate at its all-time low of 0.1% on June 9.

The launch of monetary tightening in Central Europe shows how global inflationary pressures – partly caused by input bottlenecks – together with the fast recovery in the region from the pandemic are sparking fears that this could set off an inflationary spiral.

The Czech central bank (CNB) raised the two-week repo rate by 25 basis points to 0.5% and the Lombard rate by 25 basis points to 1.25%, leaving the discount rate unchanged. It was the first change in the rates since a 50bps cut in May 2020, and the first rise since February 2020. Only two of the seven monetary board members voted against the increase.

"It is possible that we will hike rates at every next monetary policy meeting, which will bring us to the level projected by the forecast...But I do not say that this will be the case. And I hope it will not be necessary," said CNB Governor Jiri Rusnok. 

Analysts expect both the Czech and Hungarian central banks to continue to raise rates at their next meetings to reduce inflationary expectations.

"The CNB has sent a signal that it needs to pull the brakes slightly due to its concerns about increasing inflation. Although this is to some extent caused by issues in production and transport and thus inflation is not driven just by rising demand, some signs of overheating in the domestic economy can be seen, despite the pandemic," said Jakub Seidler, chief economist at the Czech Banking Association. 

"It is rather a demonstration of the willingness to tame inflation even under very uncertain conditions and thus anchor inflation expectations not only on the market but also among consumers and ease their fears of high inflation," Raiffeisenbank's chief economist Helena Horska said.

Capital Economics predicts the Hungarian central bank – which raised the base rate by 30 basis points to 0.9% – to make 60 basis points of raises by March.  Forward rate agreements (FRA) on the interbank market suggest that the markets are pricing in a 25bp hike in one month, a 50bp increase in three months and 90bp in six months.

Analysts predict the Czech central bank will make two more rate rises this year. The Czech central bank has long been the most independent and dynamic monetary authority in Central Europe. It cut rates sharply at the outset of the pandemic and now looks set to raise rates quickly as Europe emerges from it. Longer term, Capital Economics forecasts the Czech central bank will raise rates to 2.25% by the end of 2023.

Central Europe monetary policymakers are more worried about inflation than their Western European counterparts, as they did not have deflation problems after the global financial crisis, and inflation is already rising fast. Inflation in the Eurozone averages 2%, compared with around 5% in Hungary and Poland – the fastest price growth in the EU. Czech inflation eased to 2.9% in annual terms in May after a jump to 3.1% in April, but this is still right on the edge of the bank’s target of 2%, with a 1% tolerance band.

Central European labour markets have remained tight despite the pandemic, and wages are starting to rise rapidly again as lockdown restrictions are lifted. In Hungary and Poland wages are already rising at or around 10% y/y.  In Czechia, the country's continuing shortage of labour is causing wages to edge up, with 3.2% growth in the first quarter.

Central Europe looks likely to close the output gap faster than other emerging markets as it opens up after the pandemic lockdown. In the first quarter the year-on-year decline in GDP was 2.1% in Hungary and Czechia and 1.4% in Poland, with leading indicators predicting a rapid rise in overall growth in the region this year.

However, the monetary tightening could crimp economic growth as Central Europe starts to recover from the pandemic. It will also push up local currencies.

The European Central Bank – which sets rates for euro adopters Slovakia, Slovenia, Estonia, Lithuania and Latvia in CEE – has no imminent plans to raise rates. ECB President Christine Lagarde said on June 10 that there was “significant economic slack that will only be absorbed gradually”, price pressure would abate next year, and that any monetary tightening now would be “premature” and would threaten the recovery.

But European industry is recovering fast as lockdowns are lifted, creating supply shortages and pushing up prices. This is bound to put pressure on the ECB, as well as have a knock-on effect on Central Europe.

IHS Markit’s flash Eurozone PMI, published on June 23, rose to 59.2 in June, up from 57.1 in May – hitting its highest level for 15 years. This sharp recovery is creating bottlenecks and increases in input prices, which companies are passing on to their customers.

At the same time, the dovish stance of the ECB will give countries in Central and Southeastern Europe some breathing space in terms of investors' search for yield, argues Gunter Deuber, chief economist of RBI.

“The ultra-strong determination of the ECB to cap benchmark yields in Europe gives markets like Czechia, Poland a certain relief from a benchmark yield perspective, while this also increases the attractiveness for European investors to look for EM Europe exposure in EU countries; the improving fundamentals and solid external positions in case of Hungary or Romania shall anchor investor appetite here,” says Deuber.