CNB likely to cut rates by half a percentage point on Thursday
Economic commentary by Jakub Seidler, Chief Economist of the CBA
The CNB will decide on monetary policy this Thursday and will also have a new macroeconomic forecast available, which will show more favourable economic growth this year compared to the February forecast, lower inflation, but also a slower trajectory for interest rates. The central bank is likely to cut rates again by half a percentage point on Thursday, but an acceleration of the rate cut this time, even with March inflation near the 2% target, is not in play due to changes in expectations for slower rate cuts abroad. The market is thus more hawkish on global developments and expects rates to fall between a quarter and half a percentage point, while analysts see the situation clearly and expect a 0.5ppt rate cut. Given the persistent inflation in the services sector, not only in the Czech Republic but also in the world, and the reassessment of the outlook for Fed and possibly ECB actions, the CNB will slow down the pace of rate cuts noticeably in the second half of the year. Next week may thus be the last half-percentage point rate cut, and further steps will follow after the traditional "quaters".
The central bank's new forecast will be revised more noticeably in several areas compared to the winter one from early February, but some of the changes are somewhat predictable and should not come as a major surprise. For this year, the CNB's winter forecast assumed domestic economic growth of only 0.6%. In the context of a more favourable revision of the data for the last quarter of last year and a relatively positive turn in confidence indicators and estimates for the German economy, growth in the new forecast should be in the range of 1-1.5%, as expected by most current estimates.
Inflation, on the other hand, will be revised downwards for this year from 2.6% closer to the 2% threshold, as developments in the first quarter were noticeably below the CNB's expectations (2.9% vs. 2.1%). By contrast, the inflation estimate for next year could rise slightly, especially in the first half of the year, when the CNB expects it to be below the 2% target. This should be due to more persistent inflation in services, stronger demand and a weaker crown. The latter is likely to be weaker in the new forecast, as shown by the current trend, where the koruna is 2% weaker against the euro since the beginning of the year compared to the CNB's assumption (25.12 year-to-date vs. 24.7 for 1H24), Chart 1.
The fact that the real decline in rates will be roughly 1 percentage point lower in H1 than assumed in the winter forecast will also play a role, and catching up with this development would require an acceleration in rate cuts, which would have a more noticeable impact on the koruna exchange rate - especially now in the context of a significant reassessment of slower rate cuts abroad. Thus, while the original forecast expected the repo rate to be below 3% in the last quarter of this year (Chart 2), the new forecast may see the level at the end of the year as high as around 4%.
The above rate trajectory will be on account of the above reasons, not because of a reassessment of the equilibrium interest rate level. This is currently assumed to be around 3% in nominal terms, but the Board has previously defined itself against this scenario, arguing that it is probably higher. However, partial information published by CNB experts suggests that the model assumption r* will not move higher in the new forecast; at most, alternative scenarios may be published, including one with a higher level of r*. Thus, if r* itself remains unchanged in the CNB model, the repo rate should still be heading towards this level in 2025 even in the new forecast.
Markets are currently extremely sensitive following the Fed's reassessment of the interest rate cut. While at the beginning of the year the market was convinced that the Fed would cut rates by the traditional "quarter" 6 times this year (i.e. by more than 1 p.p.) it now expects roughly one cut (and possibly none). Thus, while the market "suffered" from a pigeon-hole bias at the beginning of the year (reading everything between the lines to mean that rates would fall faster this year), it is now in the opposite mode and will likely interpret the new forecast and the press conference announcement in a hawkish fashion (rates will go down more slowly this year). This is already evident in market expectations themselves, with the market significantly revising its estimate of the speed of the CNB rate cut. While at the end of February it was still expecting the CNB's main rate to be around 3% at the end of the year, it now expects a level of around 4.25% (Chart 3). More cautious expectations are then priced into the rates for Thursday's meeting itself, with the market not expecting even a 0.5 p.p. rate cut, while analysts' expectations according to a Reuters poll are clear, with all 15 economists polled expecting a half-percentage point rate cut. This seems to be the most likely scenario for Thursday's meeting, even given earlier statements by CNB officials.
