Statement of the Bank Board for the press conference following the monetary policy meeting

At its meeting today, the Bank Board of the Czech National Bank increased the two-week repo rate to 5.75%, i.e. by 0.75 percentage point. At the same time, it increased the discount rate to 4.75% and the Lombard rate to 6.75%. Five members voted in favour of this decision and two members voted for leaving rates unchanged.

The decision adopted by the Bank Board is underpinned by a new macroeconomic forecast. Consistent with the baseline scenario of the spring forecast is a further sharp rise in market interest rates. In the baseline scenario, the central bank sets interest rates in order to achieve the 2% target at the standard monetary policy horizon. However, the Bank Board decided to tighten monetary policy more moderately. In the context of significant risks and uncertainties in both directions, it took into account, among other things, the message of a scenario featuring a more distant monetary policy horizon than the standard one used in the Czech National Bank’s forecasting system.

Russia’s invasion of Ukraine has slowed the growth of the global economy, which will moreover face strong inflation pressures – driven mainly by a sharp rise in commodity prices – for longer. The outlook for economic growth in the effective euro area this year and the next has thus been revised down, due partly to longer-lasting supply chain disruptions. A jump in prices of most commodities and problems in global production chains have led to an increase in the outlook for producer prices, and to a lesser extent also consumer prices, especially for this year. The European Central Bank is expected to react by tightening its monetary policy this year and the next.

The Brent crude oil price outlook has risen markedly, mainly because of the impact of the sanctions imposed on Russia, and is subject to exceptional uncertainty. The same applies to global gas prices. The expected euro-dollar exchange rate is slightly weaker, owing to a larger-than-expected impact of the war on Europe than on the USA and stronger tightening of US monetary policy.

GDP growth will slow considerably this year, with economic activity even contracting slightly year on year in the second half of the year. This will be due largely to falling household consumption. Households’ real income will decline this year, owing to rapid growth in living costs, and their sentiment has simultaneously worsened. Firms will rein in investment because of subdued domestic and external demand and a deterioration in their financial situation as a result of surging prices of energy and other commodities and materials. Growth in external demand is being adversely affected by the war in Ukraine, which, moreover, is exacerbating the problems in global value chains. Exports will thus remain subdued this year and firms will be forced to make increased additions to inventories until mid-2023. However, the contribution of net exports to economic growth will be slightly positive this year due to a noticeable cooling of domestic demand. GDP growth will recover next year.

Headline inflation will rise further in the next few months, reaching almost 15% in late spring and early summer, with all its components contributing to the increase. Core inflation will continue to reflect both strong producer price inflation abroad and fading substantial domestic cost and demand pressures. Rising commodity prices will lead to a further marked increase in administered price inflation and growth in food prices. The strong cost pressures peaked at the start of this year, driven by both growing import prices and the overheating domestic economy and labour market. The fading of the above factors will cause the cost pressures to diminish already this year. Next year, a halt in growth and subsequent slight decrease in import prices will act in the same direction. This year’s double-digit inflation will thus fall quickly in the first half of next year and return close to the 2% target in late 2023. The previous rapid increase in domestic interest rates will also contribute substantially to the drop.

Consistent with the baseline scenario of the spring forecast is a further sharp rise in market interest rates until mid-2022, followed by a gradual decline from autumn 2022. In the baseline scenario, the central bank sets interest rates in order to achieve the 2% target at the standard monetary policy horizon of 12–18 months, i.e. in 2023 Q2 and Q3. The forecasted rise in rates thus arises from an unreserved response to a combination of exceptionally strong price pressures from abroad and persisting domestic inflation pressures, reflected in accelerating and broad-based price growth. The monetary policy tightening will support the desired cooling of domestic demand pressures and reduce the transmission of imported inflation to domestic prices. Together with an easing of the current extreme foreign price pressures, this will lead to inflation falling close to the target in the second half of 2023. Interest rates in the forecast thus start decreasing gradually in the autumn.

The koruna-euro exchange rate will firm to CZK 24 to the euro in Q2 as a result of a widening of the interest rate differential vis-à-vis the euro area. According to the forecast, the koruna exchange rate will fluctuate in a wider range just above this level next year. Stronger appreciation of the koruna will be prevented by still fevered sentiment on global financial markets related to the war in Ukraine and continuing difficulties in international trade, which, coupled with high commodity prices, will be reflected in a sizeable Czech current account deficit. This will be joined by a tightening of the European Central Bank’s monetary policy amid a gradual decline in domestic interest rates at the end of this year. The CNB is increasing the trade volumes in its sales of income on international reserves in order to restrict growth in its balance sheet.

By comparison with the winter forecast, the inflation outlook is significantly higher, especially for this year. By contrast, expected economic growth this year is markedly lower than in the previous forecast and will remain below 1% for this year as a whole. Conversely, the forecast for next year has been revised towards faster economic growth. Domestic interest rates are noticeably higher this year and the next by comparison with the winter forecast. The koruna-euro exchange rate is weaker next year.

The Bank Board assessed the uncertainties and risks of the baseline scenario of the spring forecast as being significant and going in both directions. The upside risks include higher-than-forecasted energy and commodity prices, a threat of inflation expectations becoming unanchored from the CNB’s 2% target and a related risk of higher growth in prices and wages in the medium term. Stronger-than-forecasted negative demand impacts of the war in Ukraine are a downside risk to inflation. The uncertainties include the future course of the war in Ukraine, the future monetary policy stance abroad and the duration of the disruptions to global value chains.

In the context of the high inflation, which is currently having a significant adverse effect on firms’ performance and households’ purchasing power, the Bank Board considers it relevant to take into account the fact that this is largely due to strong external price shocks outside the control of domestic monetary policy. Therefore, a simulation featuring a more distant monetary policy horizon was prepared in addition to the baseline scenario. In this simulation, the central bank abstracts from inflation, which is being directly affected by strong exogenous price shocks that will manifest themselves in inflation at a horizon of 12–18 months. Importantly, the simulation – like the baseline scenario – assumes that inflation expectations remain anchored to the 2% target, thus helping inflation return close to it.

In the scenario featuring a more distant monetary policy horizon, the market interest rate path is lower than in the baseline scenario, especially this year. The rates increase to almost 6%. The exchange rate of the koruna is weaker than in the baseline scenario, due to a substantially narrower interest rate differential. The lower interest rates and weaker exchange rate lead to higher inflation. Even in this simulation, however, inflation falls to single figures next year, although the return to the 2% target is delayed until 2024.

The Bank Board increased the two-week repo rate by 0.75 percentage point to 5.75%. The interest rate increase is more moderate than in the baseline scenario because it takes into account the extreme external cost pressures underlying the surge in inflation this year and the exceptionally high uncertainties and risks of the forecast. When making its decision, the Bank Board took into account, among other things, the message of the scenario featuring a more distant monetary policy horizon. The Bank Board disagreed with the scenario as regards the upside risks to inflation, mainly because of the threat of inflation expectations becoming unanchored. It therefore raised interest rates more than implied by this scenario. Monetary policy may be tightened further at the forthcoming monetary policy meetings.