Recent inflation prints have been surpassing all expectations, yet the koruna is still hesitant to appreciate, weighed down by global events. Though the CNB acknowledged that there are significant uncertainties in the global economy, it did not discourage the bank board from delivering a surprise hike in June. Circumstances have not changed much since then, so we believe the CNB will use this opportunity to move rates closer to the neutral level as soon as its August meeting. Beyond changing of our rate hike estimates, we also adjust our forecasts for the EUR/CZK given changes on the market.
The June hike came as surprise to analysts, as the CNB’s May forecast indicated that central bankers would wait until the turn of 2018-19 to make their next move. The CNB cited two main reason for its decision to hike ahead of the plan. First, the elevated EUR/CZK exchange rate is major pro-inflationary risk to its forecast. The koruna has reacted to the global political stress, suffering along with other EM currencies. We described this in a recent report (see http://bit.ly/FXrevEN). The situation has not changed since then, and the exchange rate is still hovering around 26. The koruna did not react to the June rate hike or on the surprisingly strong inflation reading. This confirms the risks we described in our latest Czech Economic Outlook (http://bit.ly/2JKkaJz). The koruna is now much more vulnerable to global financial market stress and reacts much less to domestic events. That said, we have revised our FX outlook and now forecast a much less aggressive appreciation path. Disinflationary pressures from the exchange rate are thus weaker than we previously expected.
After soft readings in the beginning of the year, inflation bounced back above 2%. The move was due partly to higher food and fuel prices, but it became apparent that the rapid wage growth from the past three quarters has finally started to impact prices. The labour market remains tight and should remain so in the coming quarters. Though wage growth might ease a bit, it should remain strong. Productivity has been increasing at a much slower pace, which suggests that increasing wages will continue to spur inflation and pressure companies’ profit margins. Inflation pressures from the domestic economy are thus likely to persist.
While external economic conditions turned pro-inflationary, the risks remain anti-inflationary. The tense global political situation represents a threat to the country’s economic development. Looming trade wars and uncertainty about Brexit negotiations have potential to hamper Czech economic growth. After the previous meeting, Governor Rusnok barely mentioned these risks. It seems that the bank board did not put much weight on them..
In light of the abovementioned developments, we change our call for the August meeting and now expect the bank board to resume the pace of one hike per quarter that it started in August 2017. Inflation is elevated, inflationary pressures persist, and the labour and housing markets are overheated. We would not expect the koruna to appreciate much after the board hikes in August. That would give the bank board a chance to move rates toward the neutral level without the risk of an overreaction on the FX market.