CNB cuts base interest rate by 0.5 percentage point

20. 3. 2024

5 min. reading

Economic commentary by Jakub Seidler, Chief Economist of the CBA

At today's meeting, the CNB cut interest rates by 0.5 percentage point, adopting a more cautious approach to easing monetary policy, presumably because of concerns about further weakening of the koruna and also about still higher inflation in the services sector. As a result, the CNB's main rate has fallen to 5.75% and is the lowest since May 2022 (Chart 1). After the lower inflation numbers of the first two months of the year, both the market and analysts had expected that the CNB might accelerate the pace of rate cuts, but after comments by CNB officials last week, expectations were revised down and today's 0.5 bp rate cut was thus fairly unanimously anticipated by both analysts and the market. Today's rate cut itself should not have a major impact on the koruna exchange rate; in this respect, the tone of the press conference will be important.

Today's decision of the central bank will traditionally have the fastest impact on the market for those products where interest rates are most closely linked to the CNB short-term rate, or the 3M Pribor. As a result, we can expect a further decline in interest rates on corporate loans, where the average rate on crown loans reached 8% in January, the lowest level since mid-2022 (Chart 2). Interest rates on deposits will also decline in line with the decline in the CNB's main rate, as already indicated by the evolution of deposit rates with agreed maturity, both for households and corporates (Chart 3). For mortgage rates, today's decision by the central bank only confirms the established trend and market expectations, which are already reflected in market rates for longer maturities. They had already started to fall at the end of last year in anticipation of faster rate cuts by central banks. As a result, market rates for longer maturities are at their lowest level since the turn of 2021 and 2022, which has also opened up room for mortgage rate cuts. Today's decision by the CNB thus fits in with longer-term expectations and the decline in mortgage rates that has begun will continue, although longer rates have been rising slightly since mid-March. In February, the average mortgage rate fell by two-tenths of a percent to 5.36%, the lowest level since June 2022 (Chart 4).

With market expectations targeting a fall in the CNB rate to around 3.25% by the end of the year, whereas after the last meeting these expectations were slightly below the 3% threshold. Thus, the market has to some extent reflected the signals coming from central bank officials, who have repeated several times that rates will not be cut so quickly this year even if inflation falls. Analysts are currently more cautious about the speed of the rate cut and expect the CNB's main rate to end the year in the range of 3.5% to 4%. Thus, in the context of the more cautious approach to rate cuts taken by the CNB today, these expectations seem more realistic.

Update after press conference

The press conference after today's monetary policy meeting was hawkish. Governor Michl mentioned that the CNB will be cautious in cutting rates further, monetary policy will continue to be restrictive and the process of rate cuts may be halted if inflation does not develop in line with estimates. The hawkish tone of the press conference follows despite the fact that two board members supported a more decisive rate cut of 0.75 bp (presumably J. Frait and T. Holub), while at the February meeting there was only one such vote. The exchange rate of the koruna thus strengthened slightly to below CZK 25.2 per euro. The market re-priced the outlook for future rates slightly upwards after the press conference and the market is targeting a CNB rate of around 3.3% at the end of this year.

The press conference said:

Inflation has fallen towards the 2% target, but the Board still sees upside risks to the forecast outlook, so the Board wants to persist with a tight monetary policy and will approach rate cuts cautiously.
The upside risks are a slower decline in inflation expectations, higher inertia in services prices and a weaker exchange rate of the koruna. The downside risk is weaker economic developments abroad.
The speed of further rate cuts will thus depend on the persistence of the low-inflation environment. A. Michl reiterated that the process of rate cuts could be halted at any time if inflation, and in particular the core part, did not develop in line with the forecast.
According to Governor Michl, the fight against inflation is not over. Governor Michl mentioned that the CNB intends to present an analysis of the calculation of the neutral rate r* in May, and this rate will probably be higher than expected in the current winter forecast. Compared to the last press conference, A. Michl put more emphasis on the inflationary effect of the weak koruna, and then mentioned in the Q&A that the CNB would not like to see further depreciation of the koruna.

The previous press conference after the CNB meeting in February sounded pigeon-holed to the market, and the koruna weakened after it, which was not desirable from the CNB's point of view. It was evident today that the CNB does not want to repeat this scenario. The signals of the conference were thus unambiguous and carried a hawkish tone. Governor Michl's main message emphasised that the CNB wanted to continue to cut rates very cautiously and preferred to have a tighter monetary policy in light of possible upside risks to inflation.

In this context, it thus seems likely that the CNB will not accelerate the pace of rate cuts in the future and will cut rates by half a percentage point at most, even at the next meeting in early May. Although the situation may undoubtedly change in light of new data, the evolution of the koruna exchange rate and the prospect of falling rates abroad, in general it seems that if the CNB has not accelerated the pace of rate cuts today, when it is falling from high levels, there is less chance that it will do so at the next meeting. The key at the May meeting itself will then be the introduction of a neutral rate, which may then change current market expectations that CNB rates will settle around the 3% level next year (Chart 5).