CNB to decide on further interest rate cuts next Thursday
Economic commentary by Jakub Seidler, Chief Economist of the CBA
The CNB will decide on monetary policy next Thursday and will not have a new macroeconomic forecast available, so it will only assess the current developments compared to the last forecast from May. The central bank will cut interest rates by 0.25 or 0.5 bps. The stronger exchange rate of the koruna and the reduction of some upside risks in the latest inflation or producer price figures play in favour of a 50-point rate cut, while the persistence of stronger growth in services, stronger growth in household consumption and wages, and slower rate cuts abroad argue for a more cautious approach. The board's majority preference now appears to be slightly in favour of a 50-point rate cut, but in the context of market expectations, a gradually weakening exchange rate and the potential for higher market uncertainty associated with next week's French elections, the board may ultimately agree on a more cautious cut, a scenario we ultimately give a slightly higher chance.
The central bank's decision on Thursday is likely to be a close one, as central bankers themselves have already indicated. A 0.25 or 0.5 bp rate cut will be considered by Governor Aleš Michl, Deputy Governor Eva Zamrazilová or Tomáš Holub, while Deputy Governor Jan Frait also admitted some oscillation between the two options, although he is more likely to lean towards a 50-point cut. In general, however, the media comments by CNB board officials suggest a slightly higher preference for a 0.5 p.p. rate cut, although some admit that they will decide only on the basis of the debate and arguments at next week's monetary meeting.
The fact that monetary policy is still restrictive given the current and expected level of inflation argues for a faster rate cut. Also, the latest inflation numbers for May brought an easing of inflation concerns. Headline inflation fell from 2.9% to 2.6% yoy, only marginally above the CNB's original estimate, and monthly inflation (and core), after accounting for traditional seasonality, was among the lower ones this year, although for services it is still well near the 5% mark after annualization (Chart 1a-d). Producer prices also generally surprised to the downside in May, confirming the unwinding of inflationary pressures across producer sectors. Some Board members may also have a negative perception of a noticeable drop in investment in 1Q24, which could indicate an over-tightening of monetary policy, although this development was probably driven by the drawdown of EU funds at the end of the year, which "seeded" the completion of investment for the coming quarter. The koruna exchange rate also surprised with a stronger level last month and was below forecast expectations (24.9 vs 25.2 in 2Q24), Chart 2. On average, a 1% stronger koruna exchange rate corresponds to a tightening of monetary policy by about a quarter percentage point, i.e. the Board may perceive a need to offset the exchange rate developments with a more significant rate cut.
On the contrary, stronger-than-expected household consumption (1% qoq in 1Q24 vs. 0.7% expected by the CNB forecast), improving retail sales (5.8% and 5.3% yoy in March and April, i.e. In a similar vein came the development of wages in 1Q24, which was also above the expectations of the CNB forecast (7% vs. 6.4%) and in particular the acceleration of quarter-on-quarter dynamics above 2% (Chart 3). Although median wage growth itself was weaker (5.5% yoy), wage pressures are indicated by both April industrial wages accelerating to 10% yoy and dynamically rising personal income tax and social insurance collections (8.8% yoy Jan-May). Further potential wage growth will then be supported by the planned increase in civil servants' wages from 1 September (c. 5-10% vs. the union proposal of +15%). Lending dynamics are also accelerating, not only for new mortgage loans but also quite strongly for new consumer loans, which have grown by almost 40% this year (Chart 4a-b). There is also a risk of a gradual acceleration in house prices, which confirm the monthly land registry values, which may bubble up again in imputed rent growth. In terms of inflation itself, 5% year-on-year price growth in services persists and the risk is a faster fading of the anti-inflationary effect of food prices, which illustrated their volatility and difficulty to predict with a 1.5% rise in April. Without the effect of food prices, annual inflation would still be 3.9% yoy. Caution may also stem from slower rate cuts abroad, both by the ECB, the Fed and central banks in the region, while the aforementioned caution has rather paid off for the CNB in the first half of the year in the context of the sharp changes in Fed rate expectations in retrospect.
From recent media comments by CNB officials, it seems that there is currently a rather slight preference for a 0.5 p. b. rate cut, but the development could slightly reverse market developments and the exchange rate of the koruna, which weakened to CZK 24.9, the weakest level in a month, on growing signals of a more significant rate cut. The market environment may then become further complicated next week due to increased market sensitivity to the risks of the French election. The combination of a more pronounced rate cut than market expectations and a negative market reaction to the results of the French election then represent a negative factor for the koruna. Short positions against the koruna are already increasing in the market, while its relatively stable and stronger level over the past month was due to the type of one-sided short positions that were gradually closed out and led to a strengthening of the koruna rather than to strong fundamentals. Depending on market sentiment and the koruna exchange rate in the week ahead of the CNB monetary policy meeting itself, the Board may ultimately conclude that a more cautious rate cut would be a safer strategy in the current market environment. This is the scenario we end up giving a marginally higher chance to. The FRA market rates are pricing in a rate cut of less than 1.5 "Thursday's" rate cut. The market is expecting rates to end the year slightly above 4% (Chart 5).
