Czech Republic Central Bank Statement

Author: | Published: 5 Sep 2017
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To better understand economic developments in the Czech Republic in 2017 we need to return to 2013. At that time, the Czech economy was languishing in the longest recession of modern times, caused by a combination of economic contraction abroad, a sharp drop in private investment and domestic budget restrictions lasting several years. As a result, the Czech economy was exposed to strong external and domestic disinflation pressures, which were accompanied by falling inflation expectations. The inflation forecasts at the time were indicating a rising risk that the Czech National Bank's (CNB) 2% inflation target would be significantly undershot unless monetary conditions were eased further. The CNB had already lowered its interest rates to zero back in November 2012, and its verbal interventions during 2013 had had only a limited effect, so the central bank decided in November 2013 to weaken the koruna to CZK27 to the euro and not allow it to appreciate below that floor. This commitment was to be achieved by making foreign exchange interventions without any volume limits.

In the years that followed, the external disinflation pressures turned out to be much stronger and longer lasting than the CNB's end-2013 forecasts had suggested. The exchange rate commitment was therefore prolonged several times. It was not until late 2016 and early 2017 that core inflation (especially imputed rent and cafe and restaurant prices) started to rise significantly. It was joined by growth in food and fuel prices. In September 2016, annual headline inflation had been at 0.5%, but by March 2017 it had risen to 2.6%. Constantly rising core inflation (running at 2.4% year on year in April) had created conditions for sustainable fulfilment of the inflation target even given the expected appreciation of the koruna after the exit from the exchange rate commitment. The CNB exited on April 6, not long after the end of the period for which the commitment to maintain a weakened koruna had applied. This was the first step towards normalising monetary policy, i.e. towards using interest rates as the main instrument again.

At the time of writing, less than two months had passed since the CNB left the koruna to float on the market. The exit can preliminarily be assessed as a success. It was performed in a highly transparent way and fully in line with the CNB's earlier communications. The volatility shown by the koruna so far does not go beyond the usual market fluctuations. The Czech currency is displaying a modest appreciation tendency (of around 2% relative to the rate of CZK27 to the euro).

The CNB's analyses have repeatedly indicated that the weakening of the koruna contributed significantly to the recovery of the Czech economy that started in 2014, to the creation of many new jobs in the economy, and to faster fulfilment of the inflation target. The Czech economy is currently operating at its potential output level. The labour and property markets are even showing signs of overheating. According to the CNB's May forecast, the economy will grow at a rate of around 3% and inflation will fluctuate close to the inflation target in 2017 and 2018. Consistent with the forecast is an increase in domestic market interest rates in the third quarter of 2017 and later also in 2018. The future path of the koruna exchange rate is still the biggest uncertainty of the forecast, especially given the market 'overboughtness' that occurred in the last few months before the exit from the exchange rate commitment. The condition of the Czech economy can currently be assessed as very good overall, thanks in no small measure to the actions of the CNB.




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