Czech Republic: CNB delivered the hike the market was expecting – Deutsche Bank

The Bank Board of the Czech National Bank decided unanimously to increase the two-week repo rate by 20 basis points to 0.25% and the Lombard rate was increased by 25 basis points to 0.50%, while the discount rate was left unchanged at 0.05%, notes the research team at Deutsche Bank.

Key Quotes

“This played strongly against our reading of board members' comments when expressing their concerns in the June minutes and other fora about how "the costs of prematurely tightening monetary policy were higher than the costs of a rather later response”. In our opinion the Board gained a lot in credibility, but it also has implicitly increased the chances of needing to reverse their actions in the midterm.”

“A key determinant in the decision seems to have been the “persisting uncertainty” about the koruna exchange rate. Implying that the tightening of monetary conditions solely via the exchange rate will not be sufficient going forward to slowdown inflationary pressures from the economic cycle. In their assessment, the Board stated that (in quarters ahead) the exchange rate may be weaker than previously forecasted, owing to the closing of koruna positions by financial investors in the absence of a counterparty.”

“The statement also mentioned developments that we had thought were good reasons for delaying a hike, indeed noting that in their view productivity adjusted costs are likely to decline going forward, increasingly offsetting the impact of faster growth in wages and economic activity. Mention was also made of antiinflationary forces from import prices, from subdued foreign producer price inflation. Consistent with our view of a gradual tightening cycle, the Board cited how the rates path to their long-run neutral level will be “strongly hampered until around mid-2018 by the European Central Bank’s ongoing quantitative easing”.”

“Another important input to the decision must have been the relatively large upward revision to their growth forecasts. In particular, the Bank's new batch of forecasts showed GDP growth projected to grow 3.6% (2.9% earlier) in 2017, and 3.2% (2.8% earlier) in 2018. These rested on the assumption of buoyant growth in private consumption and a projected recovery in investment, especially in the government sector, as a result of higher drawdown of EU funds.”

“We retain our outlook for a very gradual hiking cycle, and see the key rate at 0.25% by year end; and 0.75% by year end 2018.”