The Czech central bank left its benchmark two-week repo rate at 0.05 percent in the board’s first decision following last month’s exit from using the exchange rate as a tool to ease monetary conditions, and lowered slightly its forecast for inflation and domestic market interest rates.
The Czech National Bank (CNB) on April 6, 2017 decided to stop enforcing a cap of 27 koruna to the euro on confidence that it would now be able to meet its 2.0 percent inflation target.
The CNB began using the exchange rate in November 2013 as an additional tool to stave off deflation after its key rate was cut the current level of effectively zero in November 2012.
As expected, the koruna immediately jumped to around 26.5 to the euro from 27.03 in volatile trading following the lifting of the exchange rate cap. Since then it has eased and was today trading around 26.8 to the euro.
By discontinuing its exchange rate commitment, the CNB has now returned to a conventional monetary policy regime with interest rates as its main tool.
However, the central bank said the koruna’s exchange rate was the main uncertainty surrounding its economic forecasts, with possible fluctuations in either direction.
“Subsequent interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna,” the CNB said, adding that it remains ready to use all its instruments to mitigate any potential excessive exchange rate fluctuations.
In its latest forecast, the CNB expects the koruna to appreciate against the euro due to a positive interest rate differential to the euro in light of the European Central Bank’s quantitative easing. However, the the central bank added that its forecast did not take into account the any rise in the koruna may be strongly dampened by investors’ “overboughtness.”
Czech interest rates are forecast to move higher in the third quarter of this year and 2018, with the 3-month PRIBOR (the Prague interbank market rate) rising to 0.8 percent from 0.5 percent this year. This 2018 forecast is down from its previous forecast of 1.1 percent, with any rate increases dampened until mid-2018 due to the ECB’s asset purchases.
Inflation in the Czech Republic is seen remaining in the central bank’s upper half of its tolerance bank for the rest of this year before easing to 2.1 percent in the second quarter of 2018 and to 2.0 percent in the third quarter – down from the previous forecast of 2.3 and 2.1 percent, respectively – as one-off factors unwind.
Headline inflation rose to 2.6 percent in March from 2.5 percent in February for the highest rate since November 2012. The CNB has a one percentage point tolerance band around its 2.0 percent midpoint target.
The economy is seen growing by 2.9 percent this year, up from its previous forecast of 2.8 percent, and then growing by 2.8 percent in 2018, driven by household consumption, a gradual recovery in investment and further growth in external demand.
The Czech economy grew 2.3 percent last year, down from 3.5 percent in 2015.
The Czech National Bank issued the following statement:
Czech holds rate, lowers inflation outlook slightly