20th September 2021

Elevated inflation to accelerate pace of monetary policy tightening

Czech inflation has significantly accelerated in recent months, which is likely to prompt the Czech National Bank (CNB) to raise interest rates faster. Inflation, which averaged 2.9% yoy in 2Q, increased to 3.4% in July and further to 4.1% in August, the highest level since November 2008. The CNB forecast was for only 3.0% in July and 3.1% in August, and the increase surprised the financial markets as well. However, the development of core inflation is more important than headline inflation for the central bank. It is adjusted for the effect of volatile food and fuel prices, which are often difficult for the CNB to influence, and core inflation thus more faithfully captures the development of inflationary pressures in the domestic economy. It reached 4.8% yoy in August, a full percentage point higher than in July. This was the record high in the history of the time series published by the central bank since 2007.

Higher core inflation has been affected by a rapid and broad-based rise in service prices. The growth of non-tradable goods prices, excluding regulated prices, accelerated from an average of 3.0% yoy in 2Q to 4.0% in July, and then to 5.1% in August. The price increased in August for 65% of non-tradable items in the CPI consumer basket, and 26% of them recorded an increase of at least one percent. Price growth in services was similarly broad in previous months. In addition, growth in imputed rentals accelerated further in August to 1.9% mom, from 1.5% in July. Given the imputed rentals’ considerable weight of around 10% to the CPI consumer basket, they contributed 0.2pp to total 0.7% mom inflation in August. The previous and continuing significant increase in the prices of building materials and construction work, and the related growth in real estate prices, is beginning to have a sizable effect on the costs of owner-occupied housing. However, the current level of imputed rentals does not yet fully reflect the previous increase in material prices. While producer prices in manufacturing rose by about 10% during the first eight months of the year, the increase in imputed rentals was about half. The growth of price pressure through this item could thus continue in the coming months. In the case of tradable items in the CPI consumer basket, excluding food and fuels, price growth also accelerated, but to a lesser extent (the August figure was 4.4% yoy).

In our view, the CNB will significantly accelerate the planned tightening of monetary policy as a result of higher inflation. We currently expect the key repo rate to reach 2.0% at end-2021, while we previously forecast 1.25%. The CNB assumed 1.50% in its last August forecast. At the next bank board meeting, which takes place on 30 September, we expect interest rates to be increased by 50bp. In our opinion, rates are likely to be increased by another 50bp in November, while in December we already expect an increase of the standard 25bp. This is fully in line with the current view of investors in the financial markets. According to our updated forecast, inflation will be close to 5.4% yoy at year-end, even if we assume that the mom rise in consumer prices will slow significantly in the coming months. Otherwise, inflation could be even higher at the end of the year. While a rate increase by the central bank will not impact current inflation, it might help push inflation expectations, which have risen in recent months, back to the 2% inflation target. We note that higher inflation expectations can very quickly be reflected in real price increases. However, high inflation itself will significantly dampen the impact of higher nominal interest rates (which is already the case now), as real rates are likely to remain deeply negative for the rest of the year.

The risk of higher inflation does not only apply to this year, but also to 2022. It is still unclear how long current supply side bottlenecks will persist, especially in the event of another COVID wave. Moreover, we are likely to see a significant rise in energy prices at the turn of the year, with the tight labour market likely influencing prices as well. Finally, we note that Czech fiscal policy continues to be very accommodative. As the CNB is expected to raise rates this year, we forecast only two more 25bp hikes in the first half of 2022, with the repo rate reaching 2.50% at end-2022 (our previous forecast was 2.25%). This is close to the level that the central bank considers to be monetary policy neutral.


Martin Gürtler

Economic and Strategy Research

Komerční banka


Members of the American Chamber of Commerce in the Czech Republic