Czech National Bank: Neutral new normal – ING

ING economists David Havrlant and Frantisek Taborsky review the Czech National Bank’s 25bp hike to 4%, decided on a narrow 4–3 vote. They highlight stronger inflation and softer growth in the CNB forecast, with 4% seen as a neutral level. The authors expect further hikes to be constrained by weakening economic activity and question the steep rate-cut path embedded in CNB projections.

CNB hike and policy trajectory

"The CNB proceeded with a rate hike on Thursday, raising the base rate to 4%, which matches the expectations of market participants. The decision was taken in a split vote as four board members favoured a tighter monetary policy setup, while three policymakers opted for rate stability. The situation is perceived as inflationary, with persistently elevated core inflation, weaker exchange rate, and a still strong housing market, along with ample credit growth, seen as the main forces to keep in check through a tighter monetary policy stance."

"As for short-term interest rate, the CNB forecast suggests a further increase up to 4.5% in the nearest future, followed by a gradual decline from 2Q27 to 3.5% at the end of 2028. We see such a trajectory rather as an alternative scenario, should inflation prove even stronger than in our forecast."

"The interesting thing is that the governor described the monetary conditions as very tight at this point, and even beforehand. Well, should our hypothesis about the need for much higher equilibrium rates in the brave new world be right, then 4% seems to be a neutral stance that just prevents inflation from systematically hovering above the target. And with the CNB rate projection landing at 3.5% at the very end of the forecasting horizon, we believe that the staff is perhaps starting to drift in the same direction, at least implicitly."

"That said, interest rates are an endogenous variable in the CNB workhorse model, so you can argue that this particular rate path enables the 2.5% economic expansion, with inflation receding towards the target. But hey, would you really be cutting rated so swiftly, while having inflation still running above your target and the economy growing around its potential? I have some doubts, but will stick to the old good maxim in dubio pro reo."

"The infamous “all options are open” mantra was brought out of its shallow grave and into the daylight once again, but the dwindling real interest rate in the outlook does not suggest it stands on solid ground. Overall, we see 4% as the new neutral normal and believe that this will enable the CNB to ride out the wave of second-round effects, provided that our real GDP and inflation forecasts are right."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)