William Malcolm

CNB Raises Key Interest Rate By The Most Since 1997

The Bank Board of the Czech National Bank today raised the key interest rate by 1.25 percentage points to 2.75 percent. Central Bank spokeswoman Markéta Fišerová informed about it. This is the most significant increase in rates since 1997. The main reason for the rise in interest rates is rising inflation, which approached the 5% mark in September. Today’s meeting of the council was attended by all seven of its members.

At the last monetary meeting at the end of September, the board raised interest rates by 0.75 percentage points. The key interest rate, on which the interest rate on commercial loans is based, then rose to 1.5 percent. At that time, five members of the CNB Board voted in favor of this decision. Two voted to leave interest rates unchanged.

The CNB’s new forecast corresponds to a sharp rise in market interest rates at the end of this year and the beginning of next year. The Bank Board is ready to continue raising interest rates in line with the forecast. This was stated by CNB Governor Jiří Rusnok at a press conference after the meeting of the Board.

“If the sharp increase of 0.75 percentage points at the last meeting was a surprise, the current step is a fundamental surprise. It is clear that the CNB is fully aware of its mission to maintain reasonable price growth, and therefore decided to take this crucial step,” he said. PwC consulting partner Petr Kříž.

Today, the CNB also raised the Lombard rate by 1.25 percentage point to 3.75 percent. The Lombard rate is the percentage rate at which commercial banks can borrow money from a central bank against a pledge of securities. The discount rate, to which, for example, penalties for non-performing loans are linked, also increased by 1.25 percentage points to 1.75 percent.

“The extent of the increase in the key interest rate means that the Bank Board perceives significant inflation risks and the need for a strong monetary policy response to prevent growth in medium-term inflation expectations. It will also be important whether and how significantly the exchange rate of the Czech koruna will strengthen, “said Radomír Jáč, chief economist of Generali Investments CEE.

According to Lubor Lacina from the Faculty of Business and Economics of Mendel University in Brno, the central bank has no choice but to give the markets a clear signal that it does not want to allow long-term higher inflation than its own inflation target. “However, the question is whether a small open economy involved in global trade and capital flows can be successful in its efforts? So until inflation returns to two percent, we can expect further interest rate increases at other CNB Board meetings,” he said.

The chief economist of the Czech Banking Association, Jakub Seidler, pointed out that, despite the rapid increase in interest rates, it is still true that this instrument will slow down inflation very slowly. According to him, its effect on inflation will not manifest itself until the horizon of one year. “The market now expects central bank rates to go further up and reach the 3.5 percent mark during the December and February talks,” he said.

Regarding the development of inflation, Seidler pointed out that in 2008 average inflation exceeded six percent and in some months the year-on-year price growth reached 7.5 percent. “Current developments increasingly suggest that we can get closer to the values ​​of 2008, which few people could have imagined a few months back,” he said.

Interest on bank deposits and loans is derived from central bank rates. Businesses have higher interest rates on investment and operating loans, and more expensive housing loans on households.

The CNB began raising interest rates in June and, together with the Hungarian National Bank, was one of the first to start tightening monetary policy. Subsequently, the central banks of Poland, Romania and Norway, for example, also began to tighten monetary policy. For example, the Polish central bank raised its key interest rate by 0.75 percentage point to 1.25 percent on Wednesday, the most significant increase since 2000.

The CNB has worsened its estimate of economic development and expects higher inflation

In the new forecast, the Czech National Bank has worsened its estimate of economic development for this year and next. GDP is expected to grow by 1.9 percent this year and by 3.5 percent next year. In the previous August forecast, it expected growth of 3.5 percent this year and 4.1 percent next year. At a press conference after the meeting of the Bank Board, the Governor of the CNB, Jiří Rusnok, informed about it. For 2023, the CNB improved the estimate to 3.8 percent from the previous three percent.

According to the governor, economic growth will be supported by robust household consumption and investment activity by companies and the government. At the same time, however, until 2022, growth will be dampened by persistent problems in global production and supply chains. “Domestic economic activity will return to pre-pandemic levels at the end of 2022,” Rusnok said.

At the same time, the central bank has significantly increased its inflation estimate. This year, it awaits an average of 3.7 percent, in August it was three percent. Next year, inflation is estimated to rise to 5.6 percent from the previously estimated 2.8 percent. In 2023, inflation should fall to 2.1 percent. According to Rusnok, inflation will approach seven percent during the winter.

At the same time, in the new estimates, the central bank still expects an average koruna exchange rate of CZK / EUR 25.6 this year. Next year, it expects an average exchange rate of 24.2 crowns per euro and in 2023 at 23.9 CZK / EUR. In August, it estimated an exchange rate of 24.50 crowns per euro for next year and 24.20 crowns per euro for 2023. “At first, the koruna will strengthen significantly in response to the sharp rise in rates. Over the next year, the pace of its strengthening will slow down,” Rusnok said.

According to Rusnok, the uncertainties and risks of the newly estimated development were assessed by the Bank Board as significant, but in summary not questioning the message of the new forecast. Risks in favor of rising prices are further disruptions in global production and supply chains, a weaker koruna exchange rate, higher inflation expectations and a sharper rise in energy and rent prices. The CNB described the consolidation of public finances by the new government as an anti-inflationary risk.

In its current August macroeconomic forecast, the Ministry of Finance expects economic growth of 3.2 percent this year and estimates an acceleration in the growth rate to 4.2 percent next year.