Czech Republic: Poor GDP data for Q3 may trigger a 25bp cut in November
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
Rationale:?The decisively?worse-than-expected GDP data for Q3 ?took everyone by surprise, and we expect it to be the trigger to launch the upcoming monetary easing cycle as early as on Nov 2. We admit that we have been defending a hold decision since the latest MPC meeting on Sep 27. Our expectation was that early GDP data would not be conclusive enough, which would make enough board members hesitate and delay the first rate cut for December. However, GDP data turned out to be visibly worse than both market and official expectations. We understand this may be considered a cop-out, but we were genuinely surprised with how worse GDP data turned out to be, which explains the shift in our expectations.
Even if the statistical office upgrades numbers when the next release is due, on Dec 1, the best-case scenario is that revised data will match market expectations (a fall of 0.3% y/y, stagnation q/q), which is still much worse than the latest CNB staff projections (up 0.3% y/y, 0.7% q/q). Furthermore, it appears domestic demand stagnated in quarter-on-quarter terms, which means a similar situation as in Q2, when household consumption fell by 4.5% y/y. It suggests that household spending is far from recovering at the rate the CNB originally anticipated, which in turn means inflation pressure will remain subdued. We should also note that the CNB's summer forecast implied rate cuts would be needed even under assumptions for stronger economic recovery, and they are likely to be even stronger now, when GDP numbers are so poor.
We should underline that poor economy data do not invalidate the concerns of a number of CNB board members about persisting inflation pressure in 2024. However, what data show clearly is that the economy is at a much worse state than originally believed, which would imply monetary policy is currently tighter than desired. We remind that even hawkish board members, like Tomas Holub and Jan Prochazka, have commented that interest rates cannot remain at their current level too much longer, as they would restrict economic recovery. We believe data indicate this is exactly the case, which is why we see the monetary easing cycle starting now, rather than in December or early 2024.
Concerns about underlying inflation will not go away, and a rate cut in November will not mean a doveish turn for the CNB. We expect that CNB language will remain very cautious, and easing will likely remain gradual, at least at the beginning. It is the reason why we don't expect 50bp cuts for the time being, at least not before there are enough data to show that underlying pressure is not as strong as feared. However, we do expect that cuts will be uninterrupted, as even hawkish board members do not wish to stifle the economy too much.
We still expect some opposition to rate cuts launching now, as the national currency has continued to depreciate against the euro, reaching its weakest level in 15 months. It is why we are ruling out sharper rate cuts for the time being, as we don't believe the CNB board would like to create conditions for import prices to push inflation upwards. In fact, we won't be surprised if some board members argue against rate cuts for that very reason. On the other hand, the ECB appears to have ended its tightening cycle, so the interest rate differential with the euro area will not rise too sharply if the CNB does gradual cuts at first. Besides, we expect there are always likely to be enough board members who support renewed fx interventions in case the national currency weakens too much, and official reserves remain considerable, at EUR 131.4bn (43% of GDP) at end-September.
Regarding the policy rate course in 2024, we expect it will be heavily contingent on inflation developments. If headline CPI inflation nears the 2% target very quickly, we can expect bigger rate cuts, at 50bp increments, before the end of Q1 2024. Under such a scenario, the policy rate could end up under 4% at end-2024. On the other hand, if the traditional repricing of goods and services at the beginning of the calendar year is stronger than anticipated, then we see the policy rate in the 4-4.50% range. Labour market developments will also play an important role, with strong nominal wage growth in 2024 likely to keep the easing pace gradual longer.
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