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Czech Monthly Forecasts - August 2016: Inflation bottoms out thanks to base effects

The Czech economy continued to suffer from declining investment activity in the second quarter of the year. The lack of public investment weighs on construction, which sharply slumped, and industrial production, which posted only mild growth figures. However, tight conditions on the labour market pressure firms to distribute more earnings to employees and thus cut their own profit margins. The share of unemployed is set to increase solely due to the seasonal inflow of fresh graduates. Inflation in July increased due to base effects, but mom price growth still remains muted. Czech GDP in the second quarter is set to record another slowdown. We believe the drop in fixed capital formation in the first quarter spilled over into the second quarter, as well. Although household consumption and net exports contributed positively, according to our forecast, their dynamics were not high enough to pull GDP growth above 0.3% qoq. In yoy terms, this corresponds to a slowdown from 3% growth to 2%.

Industrial production growth suffers from declining investment activity and shutdown of the main refineries. The sector that saves industrial production from posting negative figures is the automotive industry, which benefits from the growing demand for cars in the euro area. Overall production growth of industrial production remained sluggish, in our view, printing only 2.7% yoy. Construction was hit hard at the beginning of the year, and its output has been improving since spring, but in a yoy comparison it is still set to report a 4.6% decline.

Car producers ensure that Czech exports keep growing. On the other hand, import dynamics remain muted. Low domestic investment activity and still relatively low commodity prices weigh on import growth, and increasing domestic demand is only able to offset it. Thus, we expect another record high external trade surplus amounting to CZK 21bn in June.  

Although decelerating economic growth does not create as many vacancies as it did last year, labour market conditions remain tight. We expect the share of unemployed to increase to 5.3% due to the inflow of fresh graduates on the labour market. The seasonal effect will be mildly offset by a decrease of seasonally adjusted series. 

Although consumer confidence has been on a downward trajectory, retail sales growth has been stable this year, which confirms the sound position of households as unemployment decreases and wage growth accelerates. We thus expect retail sales in June to increase 5.8% yoy. Car sales advanced 7.4%, according to our calculations.  

Although we expect only 0.1% mom growth of consumer prices, the base effect will push July’s headline inflation to 0.3% from 0.1% in June. Mom growth was impeded by fuel prices, which slightly declined in July as a result of lower oil prices following the Brexit referendum. Food prices should also act negatively due to seasonal effects. Yet both items will have a strong positive impact on yoy inflation as prices declined sharply in the same period last year. Core prices were, according to our estimate, the driver of mom price dynamics, with a 0.3% mom increase.