Czech Central Bank Has Fewer Reasons to Hike, Vice Governor Says

Interview of Jan Frait, CNB Deputy Governor
By Peter Laca and Krystof Chamonikolas  (Bloomberg 14. 6. 2022)

The case for raising Czech interest rates has weakened in the past weeks, according to a senior policy maker who has been seen as a potential swing vote in next week’s decision.

While price pressures in some parts of the economy are still “relatively strong,” anti-inflationary signals have recently prevailed, Vice Governor Jan Frait said in an interview Tuesday. In an unusually tight vote to keep the main rate at 7% in May, Frait decided in favor of keeping interest rates put.

“In retrospect, I believe I was right to support holding rates last month, because subsequently published data suggest that price pressures will be easing,” said Frait. “I can still see some arguments for raising rates, but I believe they are weaker than at the last meeting.”

Declining global commodity and producer prices, as well as weakness in local retail sales are all manifestation of tighter monetary conditions at home and abroad, as is industrial production and easing demand for loans, according to vice governor.

A rate hike from the Czech National Bank might still come if fresh domestic price pressures emerged, or if major central banks were to tighten policy more than expected, which would potentially weaken the koruna, he said.

Wage Growth

The $300 billion economy is struggling to emerge from a mild winter recession, with double-digit inflation curbing household demand and the highest interest rates in more than two decades cooling corporate investment. The bank sees inflation falling to single digits this summer, from 11.1% in May, and returning to the 2% target by around the middle of next year.

Still, rapid wage growth driven by the lowest unemployment in the European Union is a potential inflation risk in the longer term, causing caution among policy makers over when they can start cutting interest rates.

Money-market prices show investors bet on at least 100 basis points of Czech rate cuts this year and another 125 basis points in the first half of next year.

While potential anti-inflationary shocks from the domestic or global economy might prompt the start of policy easing still this year, the current trends suggest that rate cuts are more likely to start in 2024, according to Frait.

Despite a considerable inflation slowdown, the central bank is still “not in a comfortable situation,” the vice governor said.

“I certainly can’t rule out that we will start cutting rates this year, but I absolutely don’t want to sound like I’m signaling it,” he said. “At this time it really isn’t my baseline scenario.”

The future interest-rate path will also largely depend on koruna, according to Frait, who said the bank should only try to avert disproportionate market moves rather than engage in overly active management of its currency.

Stronger Currency

“If there are large swings that are caused by external shocks and which aren’t rational or based on fundamentals, then we have sufficiently large reserves to step in and prevent excessive depreciation,” he said.

The central bank has repeatedly signaled its preference for a stronger currency as a way to target the country’s biggest export-oriented and foreign-owned companies that are relatively immune to local interest-rate changes because they increasingly take cheaper loans in euros.

Raising local borrowing costs more would create undesirable “distribution effects” and effectively penalize businesses that are not able to borrow in euros, according to Frait.

“The question is whether a further increase in interest rates, which according to macroeconomic models would cool the economy, really brings any significant value in this situation,” he said.