CNB Minutes: Inflationary Risks Are Starting To Materialise

(MENAFN- ING) Road paved with inflationary risks

The Bank Board assessed the balance of risks to price stability as tilted to the upside, with Governor Ales Michl stressing the need to maintain a hawkish stance. The current monetary policy setting was deemed adequate, with a strong koruna and elevated market rates helping the sufficiently tight setup. Core inflation is seen as too high, further driven by still-robust price dynamics in the service sector. Food prices are perceived as a significant risk to price stability, as the fundamental factors, along with the low comparison base, make renewed growth almost inevitable. Second round effects linked to the protracted oil price shock seem rather muted so far.

Nevertheless, Deputy Governor Eva Zamrazilova emphasised that the situation may change should the conflict become even more protracted. Strong global energy prices bring upward risks for electricity and natural gas prices for households. Wage growth remains relatively upbeat and above the level consistent with meeting the inflation target, despite the recent downward revision, as Jakub Seidler stressed, particularly in combination with weak productivity growth. Jan Prochazka noted that wages are continuing to recover lost purchasing power.

Real wages took a serious hit in the past Source: CZSO, ING, Macrobond

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Jan Frait does not see clear evidence of strong demand in the domestic economy, which he considers an argument for a cautious approach in terms of timing and the calibration of further policy responses. Jan Prochazka characterised the domestic economy as not overheating, while an acceleration of economic activity cannot be expected without a visible recovery in foreign demand. Still, the policymakers assess domestic demand as relatively resilient. Strong growth in lending to non-financial corporations is not yet seen as a clear sign of a credit boom. That said, according to Jan Frait, any further acceleration in overall credit growth would suggest that monetary conditions are not restrictive enough.

Rate rise is coming in November

We read the Minutes as more hawkish than last week's press conference, highlighting the pro-inflationary risks at every turn. There is a clear commitment to tighter monetary policy, if needed. The overall impression is that a higher base rate would be implemented without much hesitation, as the economy is deemed strong enough to withstand tighter conditions.

The situation has shifted, especially in terms of stronger oil prices, higher electricity and natural gas prices in Europe, and a weaker koruna. With all the identified pro-inflationary risks starting to materialise, a 25bp rate increase at November's meeting is the likely outcome. At the same time, the economy's performance has moved into the spotlight, leading us to believe that any tightening will proceed with a degree of caution.

Hike, baby, hike Source: Macrobond

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The question is, how much tightening is needed to keep inflation in check at the relevant monetary policy horizon. Indeed, the impact of monetary adjustment needs time to work through the economy, with the full effect arriving with an approximate one-year lag. And with economic activity likely coming under pressure due to the protracted Hormuz conflict along with robust energy and basic materials prices, concerns over real economic activity and adverse impacts on household spending will gain traction. We expect the Czech National Bank to proceed step by step, with little appetite for sacrificing economic growth down the road. But sure, even more tightening after November's rate hike cannot be excluded given the course of global events.

Everyone is watching everyone else

A clear distinction between the short-term and the long-term, the transitory and the permanent, makes a lot of sense, as these fundamentally vary in their implications. At the same time, none of the monetary institutions operates in a vacuum, so the steps taken by the Federal Reserve and the European Central Bank clearly enter the reaction function of the Czech National Bank. And this consideration could gain prominence in a period of extended global turmoil, as a weaker exchange rate risks adding to imported inflation.

Negative real rates are a thing of the past, perhaps Source: Macrobond

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And here we observe some non-negligible differences among the crucial monetary institutions when it comes to their starting positions. This matters all the more as the global supply shock drags on, and the conflict evolves from a temporary disruption into a more permanent feature. The Fed and the CNB did not rush into rate reductions after the Covid-induced inflation wave, exacerbated by Russia attacking Ukraine. And here they stand with real interest rates still hovering above the zero bound. In contrast, the ECB's real interest rate has remained negative since March. Indeed, the eurozone's real interest rate drifted into what ancient mapmakers would have called Hic sunt dracones territory ("here be dragons").

Along with domestic price pressures, the CNB will consider the policy path of the Fed and the ECB more carefully in such a turbulent period, as a weak koruna would only add fuel to the fire of strong energy prices. On the other hand, businesses and households may start to crack under the pressure of high energy and borrowing costs at some point in the future. So what interest rate will be needed to steer the Czech economy through these rough waters? As always, the answer will reveal itself only gradually. But with both the Fed and the ECB either willing or compelled to raise rates further, additional tightening by the CNB cannot be ruled out.

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