Czech Republic: CNB cut by 25bps in February to allow itself more flexibility - minutes

• The consensus is that the policy rate should remain above the neutral level priced in by markets, but below its current level
• The debate had a much more hawkish tone than implied in the post-meeting statement
• There were plenty of concerns voiced, regarding sticky food and service price inflation, property prices, a tight labour market
• Some board members see the impact of US trade tariffs as anti-inflationary, diverting tariff-hit goods to European markets
• Yet, the current urge for relaxing fiscal policy in Europe may counteract that quickly
• Given how food prices are gaining pace, we see headline inflation nearing 3% in February, which will likely cause another pause in monetary easing
• However, this will still allow for a 25bp cut in May, and possibly even a third one in August
• Still, we feel the CNB is bracing for another supply price shock, so tightening monetary policy in late 2025 cannot be ruled out

The CNB board cut the policy rate by 25bps to 3.75% to allow itself more flexibility when risks to inflation arise, according to the?minutes?from the MPC meeting on Feb 6. In a nutshell, the board believes that monetary policy remains restrictive even at a lower level of interest rates, but it remains cautious about upcoming risks to growth and inflation. The consensus appears to be that the policy rate should remain above the neutral level currently priced in by markets, which is somewhere within the 3-3.25% range, though without a commitment to a certain level. This approach likely means that we will see at least one more 25bp cut in H1 2025, though depending on certain developments, it could be the last. It also explains why the vote in February was unanimous.

The debate had a much more hawkish tone than implied in the post-meeting statement

The tone of the debate was quite more hawkish than implied by the post-meeting statement. Even historically dovish board members like?Jan Frait?said it was crucial to keep interest rate levels higher, considering the risk of capital overflow to the US and a possible CZK depreciation. A more dovish-minded opinion came from?Jan Kubicek, who argued that long-term interest rates had remained stable over the past year, which allowed room for further monetary easing in the short term.?Jan Frait,?Eva Zamrazilova,?Jan Kubicek?and?Jakub Seidler?all emphasized on still strong labour market pressure, which is expected to keep pushing nominal wages upwards. Furthermore, stronger-than-expected GDP growth in Q4 2024, driven primarily by household consumption, is likely to create demand-pull pressure on inflation.?Seidler?added that the strong retail sales increase in December was not yet reflected in the CNB staff?forecast, and it could be the source of even more pressure on inflation.

Food and service price inflation was outlined as the primary domestic risk.?Zamrazilova?argued that food price growth was likely provoked by rising demand, but there was no such explanation for the increase in service prices.?Jan Prochazka?opined that there was a shift in consumption from goods to services, causing capacity constraints in the service sector, and thus rising prices through wage pressure. Still, the majority on the board appeared to agree with the notion that service prices have more or less caught up to goods' price levels, explaining the modest month-on-month increase in January.?Kubicek?added that if the HICP weights were used for core inflation, it would be above the headline (at 3.8% y/y in January), as services had a much bigger share in that index.

The potential impact from US trade tariffs is considered anti-inflationary, mostly because of expectations that tariff-hit goods will be diverted to European markets, according to?Jakub Seidler?and?Jan Frait. On the other hand,?Frait?pointed out that the resulting urge to relax fiscal policy in Europe could counteract and fuel inflation. Further risks are generated by the already high uncertainty of fiscal policy sustainability in developed countries. In that regard, the alternative scenarios in the forecast, which assume US trade tariffs on EU exports, do not contradict further monetary easing.?Prochazka?went as far as saying that the policy rate level that would allow more flexibility was neither 4% not 3.75%, effectively saying he will certainly back another 25bp cut.

We expect the CNB to tread cautiously, so another pause in March appears likely, followed by a 25bp cut in May

Given the tone of the debate, we expect that the CNB board will tread carefully and not rush to ease monetary policy. There is plenty of uncertainty currently, and the board is clearly aware of potential risks. Thus, what we expect to happen is that the board will be particularly sensitive to price data. If food prices continue to generate higher-than-expected pressure on inflation, then a pause at the MPC meeting in March is basically a done deal. The board will have enough information, as final CPI data for February will be available before the next MPC meeting on Mar 25, along with early price data for March. This doesn't rule out a 25bp cut in May, and in fact, we expect it will be the most likely scenario. The latest news from the US only confirms our expectation that trade tariffs are imminent, and likely worse than anticipated. For example, it appears VAT will be considered a non-tariff barrier, which would imply a 29% tariff on German car exports (10% EU-wide tariff + 19% standard VAT rate).

Yet, we feel that these events will take some time to unfold, even though we expect trade barriers to increase before the end of the year. This is consistent with the consensus on the CNB board that it needs to create more flexibility to react to potential risks, so we would argue a policy rate at 3.50% sounds as an acceptable compromise to everyone. Yet, it will be difficult to justify a 25bp cut if food prices push headline inflation close to 3% in February, which is why we are not that strong on the cut arriving in March.

We feel the CNB is preparing for a new price shock on the supply side, as we expect US trade tariffs to provoke a global chain reaction

However, there is another crucial implication from the debate on Feb 6, namely that the CNB is getting ready to tighten monetary policy if it needs to. While this was not said explicitly during the debate, we got such a vibe from some board members, who are likely bracing for a new supply side price shock. We take some issue with remarks how US trade tariffs could lower inflation pressure in Europe, as we doubt tariffs will show up along the US-Europe trade channel only. Instead, we expect similar reciprocal tariffs across the globe, with countries like China using US trade policy as an excuse to levy tariffs of their own. This will hit Europe harder than most, given its reliance on Chinese raw materials, so we expect US tariffs to cause a chain reaction and a global price shock.

Under such a scenario, it will be much better if the starting level of the policy rate is lower rather than higher, which is why we consider another 25bp cut as guaranteed. In fact, the CNB could even deliver a third 25bp cut in June or August, provided that price levels allow it. However, we now completely allow for a situation where the CNB starts tightening monetary policy again, likely in late 2025, in response to cost-push inflation. Thus, we consider a policy rate of 3.50% as the likely level it will close at the end of 2025. We don't expect these concerns to be voiced in public for now, as the odds are they can trigger a further increase in inflation expectations. However, we consider it a complacency to discard such a scenario.