The slowdown in inflation to 2.4% in October appears to be only a temporary respite. Food prices have likely reversed their previous disinflationary trend, higher energy prices are slowly beginning to feed through to consumer prices, and core inflation has likely accelerated slightly above 3%. Therefore, I expect inflation to pick up again toward 3% by the end of the year and at the beginning of next year due to base effects. It is precisely the continued strong growth in core inflation that will likely lead to a quarter-percentage-point increase in the CNB’s interest rate to 4%. However, raising interest rates alone cannot be the sole remedy for the Czech Republic’s persistently elevated core inflation.

In November, the CNB is likely to raise its 2-week repo rate by a quarter of a percentage point to 4 percent. The central bank is facing not only higher energy prices but also persistent domestic inflationary pressures, as core inflation has returned to above 3 percent. The CNB can likely no longer rely solely on higher long-term market rates, which have dampened the mortgage market. The oil shock presents the central bank with a difficult combination of higher inflation and weaker economic growth. Consequently, Its projected policy rate path is therefore likely to remain below current market expectations of around 4.75% in summer 2027. This stagflationary dilemma is also illustrated by October’s weaker economic sentiment, alongside higher price expectations and still-strong household spending intentions.

The growth in banks’ nominal profits must be viewed in the context of the overall economic trend. Compared with the pre-pandemic year of 2019, bank profits in previous years grew more slowly than nominal GDP, household wage income, and government tax revenues. This depends not only on the base year but also on whether we are comparing the current level or the average annual amount of bank profits over the entire period, in which case the gap relative to the rest of the economy is more pronounced. Nevertheless, it is true that the banking sector’s growing profits are not driven by net interest income, but rather by cost efficiency—thanks in part to the solid performance of the Czech economy.

Compared to August, their volume increased by 5%, even though in recent years it has typically declined month-over-month in September

The market price of three-year funds has risen by approximately 1.4 percentage points since February, while mortgage rates have risen by roughly one point. The rise in market rates has thus been only partially reflected in mortgage rates so far. It is important to distinguish between the aggregate offered rate, the rate for the most commonly chosen fixed-rate term, and the interest rate that the client actually negotiates. The spread between mortgage and market rates—which should not be confused with net profit—has long been among the lowest in the EU for banks in the Czech Republic and has even fallen below its long-term average in recent years. This is also consistent with banks’ lower net interest margin, expressed as the ratio of net interest income to assets.

The acceleration in September inflation from 1.9 to 2.5 percent year-over-year is roughly half due to last year’s low base. Although consumer prices remained flat month-over-month in September, this still represents a stronger trend than is typical for this month. The structure of price growth also deserves attention. Food prices continue to have a disinflationary effect, but their decline was not enough to offset higher prices for alcohol, fuel, and energy, nor the persistent domestic price pressures. Real estate asking prices returned to a stronger pace in the third quarter, which is, however, consistent with a milder future 8 percent year-over-year growth. If detailed data confirm that domestic inflationary pressures remain elevated despite slightly higher suvbey-based unemplyoment, a hike in the CNB’s base rate from 3.75 to 4 percent at the November meeting will be a relevant option.

Strong demand for loans and excellent repayment performance on mortgages and business loans continued into the second month of the summer vacation season

The Czech economy grew by 0.3% quarter-over-quarter and 1.8% year-over-year in the second quarter. This is a slower pace than before, and growth for the first half of the year stood at 0.6%. The weaker GDP growth is also consistent with slower growth in value added and productivity. The latter reflects continued employment growth, which is now contributing to high growth in unit labor costs. Meanwhile, households are maintaining a high savings rate, which returned to 19.9% in the second quarter. It also remains true that fixed investment is driven by the construction sector, while investment in ICT, machinery, and weapons declined in the second quarter, falling even below pre-COVID levels.

The growth in real estate prices slowed slightly in the second quarter. Year-over-year, real estate prices were up 8.6%, while in the first quarter they had risen by 10%. The slowdown is primarily due to a slight quarter-over-quarter decline in prices for new properties in Prague. Older housing, on the other hand, continues to maintain roughly 10% year-over-year and annualized growth. The price and cost index for owner-occupied housing traditionally showed a weaker pace, but the 1.6% increase ranks among the stronger ones over the past two years. Over the past fifteen years, the increase in the cost of acquiring real estate—including self-help construction and repairs (so-called “owner-occupied housing”)—has accounted for 51% of the increase in the real estate index, i.e., the house price index. While quarterly acceleration of disposable income fit the real estate price growth, its annual growth reamined weaker.

September confidence indicators showed a slight deterioration in overall economic sentiment, but they do not represent a significant negative signal for the economic outlook. Sentiment in the services sector, in particular, is deteriorating, while the retail sector and consumers are sending more favorable signals. Moreover, improved expectations in the industrial sector suggest that the September decline in sentiment may be temporary. For the CNB, in addition to the slight weakening of confidence, slightly more favorable employment expectations and higher price expectations—particularly in the construction and services sectors—will also be important.

Since 2022, the relationship between oil prices and fuel prices has changed significantly. A model based on pre-war correlations would currently indicate that gasoline would be about eight crowns cheaper and diesel nearly 12 crowns cheaper. However, the data suggest that the bulk of the difference does not arise from average gas station margins, but rather in the European refining and wholesale markets. The analysis breaks down price markups along the supply chain, describes structural problems in the Czech and Central European diesel markets, and also examines the possibility of a fiscally neutral excise tax structure during oil price shocks. On the supply side, there is uncertainty regarding supplies, disruptions in ties to Russian oil, and limited capacity, while Czech and Central European demand for diesel remains strong. This combination is putting upward pressure on prices.

The September decision was unanimous, and the Bank Board did not consider it necessary, for the time being, to follow up on the June rate hike with a further tightening of monetary conditions. Furthermore, financial conditions are tightening due to rising longer-term market rates, which are also affecting lending. In November, the CNB will revisit the question of whether to keep the rate at 3.75% or raise it to 4%. The second option seems more likely to me, unless there is a significant cooling off in domestic data or a normalization of commodity prices. Meanwhile, the market expects an even more pronounced rate hike to 4.75% over a nine-month horizon. However, the Czech yield curve is also significantly influenced by foreign rates, partly due to domestic factors. The CNB’s leeway to not place greater weight on these developments will depend primarily on the future trajectory of core inflation and the koruna exchange rate, the importance of which was also emphasized by the governor.

Activity declined by 13 percent in terms of volume compared to July

According to my estimate, the overall year-on-year growth in realised residential property prices slowed from 14.0% to 12.3% in the second quarter. Prices of existing flats nevertheless continued to rise at a very strong pace, while prices of new flats in Prague fell by 1% quarter on quarter according to the Czech Statistical Office, leading to a marked slowdown in their annual growth rate. However, the surprising decline in Prague new-build prices is not broadly corroborated by transaction data from Flat Zone, and I would therefore not yet interpret it as the beginning of a more pronounced cooling of the housing market, although the gradual normalisation of the mortgage market should, with some lag, also be reflected in housing market developments. This should be transmitted through two channels – the CNB's macroprudential regulation and higher market interest rates.

Inflation in August accelerated slightly to 1.9% year-over-year, but a more significant problem remains beneath the surface: core inflation remains at 3%, and service prices have accelerated again on a month-over-month basis. Labor market data point to a mild pro-inflationary risk rather than a disinflationary one. The CNB may leave interest rates unchanged at 3.75% in September and wait impatiently for the November forecast.

July’s industrial and foreign trade figures pointed to a weaker start to the third quarter. The overall economic picture, however, remains mixed: weaker industrial output and exports contrast with more resilient construction, retail, and services. The data thus pose a certain risk to the expected modest recovery of the Czech economy in the third quarter, projected at 0.6% quarter-over-quarter. Moreover, the weakness in July’s industrial output was not across the board, and a solid trend in production outside the automotive sector and energy-intensive industries remains evident, as confirmed by export figures. Foreign trade remains under pressure from higher energy prices. Trends in residential construction remain favorable for both housing starts and completions, despite renewed weakness in building permits.