Czech Republic: New CNB forecast slashes GDP projections, remains upbeat on exchange rate
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
The new CNB staff forecast slashed GDP projections for 2024 and 2025 while remaining upbeat about exchange rate developments, according to the?early look?to the latest Monetary Policy Report. As seen from?the preview?of the forecast, the CNB halved its GDP growth projections for 2024, down to 0.6%, and lowered its 2025 projection to 2.4% (down 0.4pps). Importantly, household consumption growth projections were downgraded, from 2.6% to 1.4% in 2024, which implies lower demand-side pressure. Poor external demand has led to less optimistic investment growth estimates, as gross fixed capital formation is now expected to rise by 3.4%, rather than 4.5% in 2024. As long as the Czech Republic's main trade partners keep reporting a stronger downturn than previously anticipated, domestic recovery will remain subdued.
Inflation projections remain virtually unchanged
Despite a worse economic outlook, the inflation forecast remained mostly unchanged, as headline inflation is seen at 2.6% in 2024 (no change) and 2.0% in 2025 (down 0.1pps). Unlike the finance ministry's?forecast, the CNB doesn't expect a considerable acceleration of inflation in H2 2024. The core inflation forecast, excluding regulated, food, beverage, tobacco and fuel prices, remains almost unchanged as well, at 2.9% in 2024 (down 0.1pps) and 2.2% in 2025 (down 0.2pps). The CNB is expecting a relatively steady development of inflation in 2024, with a slight dip in Q3 2024, but overall, staying within the upper side of the CNB's tolerance band (2%+/-1pp). This is obviously what triggered the 50bp cut delivered on Feb 8, as with a benign inflation forecast, it makes no sense to hold the brakes too tightly.
No major revision of labour market indicators, either
There were no major changes to the other indicators, either. Nominal wages are expected to rise by just under 6% in both 2024-2025, leading to real wage growth of about 3-4% in each year. The LFS unemployment rate is expected to average at 3% in both 2024 and 2025, which appears as a new equilibrium, though still a very low level in absolute terms. The CA balance projection was upgraded to a slight surplus in 2024-2025, but this is in line with recent developments. There are slightly less optimistic projections about the fiscal sector, as the general government deficit is expected at 2% of GDP in 2024 (up 0.2pps) and 1.5% of GDP in 2025 (up 0.5pps). While the CNB likely sees the fiscal impulse as still low, higher public spending could have some pressure on inflation.
The forecast implies a very steep monetary easing in H1 2024, so it is easy for CNB board members to ignore it
Going to the policy rate projection, an item that often provokes heated debates in financial markets, the model continues to imply a very sharp pace of monetary easing in H1 2024. It is the reason the post-meeting?statement?said that the policy rate would maintain a trajectory above the one envisaged in the forecast. Yet, it is a very low bar, as the model implies cumulative rate cuts of about 225bps in Q1, 50bps in Q2 and 100bps in Q3, bringing the policy rate to 3% at the end of 2024. Before we continue, please note that the forecast provides only quarterly averages, so we are effectively trying to reverse engineer monthly values, so the odds are our estimates are not very precise. Even then, we can safely assume that the forecast is very gung-ho about monetary easing, so it is straightforward for board members to say they intend to lower interest rates at a slower pace.
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We remind that this is only an extrapolation made by the model, which shows what the policy rate should be if inflation is to converge to the 2% target in the period relevant for monetary policy (12-18 months). This is not, and has never been, policy guidance, and board members have always had full discretion to ignore the model's results.
Monetary policy impact
We had our suspicions that this is what the forecast will show, and we were not wrong. Under such inflation projections, it indeed makes sense for the CNB board not to hold back and back at least 50bp cuts. It has led to some discrepancy between the public remarks of most board members and their voting pattern, though it only illustrates how dynamic economic developments have continued to be. We suppose we will be taking remarks by board members with a bigger grain of salt in the upcoming months, as it is clear that economic events are often getting ahead of the board's expectations.
As far as future policy course is concerned, we expect that we will see at least two more 50bp cuts in the next two MPC meetings, possibly even three. As far as the MPC meeting in June is concerned, we expect the decision will be dependent on available data, such as inflation and exchange rate developments. If inflation surprises on the downside, we may even see a cut bigger than 50bps in H1 2024, though we are sceptical inflation will ease that quickly. As far as the exchange rate is concerned, it will largely depend on both geopolitical developments (that are very difficult to predict) and the ECB's monetary policy. Given the ECB's reluctance to start cutting rates quickly, it may lead to a 25bp cut in June, rather than a 50bp one.
We expect the true reassessment of the CNB's policy will take place at the August MPC meeting, when the summer staff forecast will be out. We expect that it will be the time when the CNB board will decide how far it is willing to go with rate cuts in 2024. Furthermore, we continue to expect that the policy rate is unlikely to fall under 4% this year, but our position may be reassessed on economic developments. This implies that the CNB may pause once in Q4 2024, which we see as a realistic scenario.