Czech Republic Central Bank Statement

Author: IFLR Correspondent | Published: 24 Sep 2019
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In mid-2019, the Czech economy grew in year-on-year terms for the twenty-third consecutive quarter. Although growth has slowed to 2–3% from 4.5% in 2017, the economy is still showing signs of overheating.

This is most pronounced in the labour market, which has been facing acute skilled and unskilled labour shortages for two years now. The number of unemployed is currently much lower than at the peak of the previous business cycle in 2008. Persisting demand for labour is the main reason for rapid wage growth. In 2018, average nominal wages rose by an extraordinary 8.1% and real wages by 6.5%. Although wage growth will slow in the future, it will continue to provide a significant stimulus to household consumption growth, which has been the main driving force behind economic growth in recent years together with corporate investment.

The rapid wage growth is the most important cause of demand-pull inflation. So far in 2019, headline inflation has been below the upper boundary of the tolerance band of our inflation target, which is 2% ± 1 percentage point. However, the slightly higher inflation is due partly to relatively brisk growth in food prices.

The CNB's monetary policy has undergone remarkable development in recent years. As a result of strengthening disinflationary pressures following the financial crisis, the CNB decided in November 2013 to weaken the exchange rate of the koruna and prevent it from appreciating below CZK27 to the euro. It used the exchange rate as an unconventional instrument within the inflation targeting regime, joining other central banks applying unconventional policies.

The need to rely on the exchange rate as a tool to counter disinflation subsided in late 2016. The CNB ended its exchange rate commitment in April 2017, leaving the exchange rate to move freely according to demand and supply on the forex market. As the intervention regime had stimulated the opening of massive speculative positions by foreign investors and financial asset purchases in the domestic currency, the evolution of the koruna exchange rate after the exit from the intervention regime was subject to uncertainty. In line with our expectations, the koruna started to appreciate following the end of the exchange rate commitment, but the appreciation came to a halt in late 2017, contrary to expectations. Since then, the koruna has been fluctuating within a relatively narrow range of CZK25.50 and CZK26 to the euro.

Whether the halt in koruna appreciation is due to the 'missing counterparty' effect for the closing of forex positions or the recent deterioration in forex market sentiment (fostering an outflow of capital into assets regarded as less risky), it opened up room for the CNB to normalise monetary policy: to return to the use of interest rates as the main monetary policy instrument.

The CNB started to increase its rates in summer 2017, raising its two-week repo rate in eight steps to 2% in May 2019. It thus embarked on a path towards a neutral interest rate level that neither stimulates nor slows the economy. Owing to significant risks and uncertainties in the external environment, monetary policy is now in wait-and-see mode. As we have room for moving interest rates in either direction, this is a comfortable situation.