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The way to Exit is free

Following 2.5% experienced in 2016, the Czech economy will grow at a rate of 2.7% this year. We will see recovered investment activity thanks to funds from the EU following last year’s slump. Inflation will be around 2.2% on average this year. The CNB will no longer have a reason to keep the crown’s rate at levels above CZK 27/EUR. The exit from the FX floor commitment mode will be the key issue this year. 

• Thanks to household consumption and the visible acceleration in the economic activity of our key trade partners at the end of last year, economic growth in 2017 will be faster than in 2016.
• The gradual start-up of the various operational programmes of the EU’s funds will also help to recover investment activity in the private sector.
• Workforce shortages will prevent a livelier investment activity and faster economic growth. We expect nominal wages to grow by 4.6% this year, the most since 2008.
• Households’ better income is reflected in higher retail sales. Households are investing their savings in real estate. Property prices are surging, also because there is little construction, primarily in Prague.
• Inflation is back. Achieving the inflation target is sustainable. This year’s price hikes will be 2.2% on average, with core inflation rising even more distinctly by 2.4%.
• The end of the FX floor implies the end of exchange rate stability. But the CNB will still seek to mitigate significant rate fluctuations on the market. Thus, the end of the FX floor does not imply the end of interventions.

The structure of this year’s growth of the Czech economy is healthier as basically all of its constituents will contribute to the growth. Exporters are set to experience another successful year thanks to the good demand from their key trade partners, in particular Germany. But imports will also grow due to stronger internal demand, and not only consumer-driven but also investment-driven imports. The reason is that unlike last year, investments should grow this year. New calls for proposals under operational programmes of the EU’s funds will also help. Both the public and the private sectors will then benefit from them. However, household consumption will again be the cornerstone of the Czech economic growth this year.

Continued economic growth will again improve the situation in the labour market. The already record employment will continue to rise, but at a much slower pace. The low rate of unemployment is now also becoming a limit for companies’ investment decisions as ‘no people’ are available. The result is wages and salaries going up. Thus, wages may grow by up to 4.6% in nominal terms this year, the most since 2008.

The period of extremely low inflation over the past three years is finally over. Accelerated inflation in late 2016 and the reaching of the 2% target will set the trend for the development in 2017. For most of this year inflation will stay slightly above the target. We estimate an average growth in consumer prices of 2.2% this year. And from the central bank’s perspective, core inflation rising by as much as 2.4% is the crucial factor. We continue to expect the exit from the FX floor commitment during the second quarter of this year. We regard Thursday 4 May, when the CNB’s Board will discuss the new inflation report at its scheduled meeting, as the most likely date.

The end of the FX floor implies the end of exchange rate stability. Despite the generally prevailing conviction that a significant appreciation of the Czech crown will follow, we see the risk primarily in a stronger exchange rate volatility causing the crown’s overshooting to either side. Speculative flows will be the reason. The CNB will still seek to correct any major rate fluctuations in the market.  Indeed, the end of the FX floor commitment does not mean the end of interventions. In the long run, a trend of an appreciating Czech crown should persist as the Czech economy converges with the euro area. However, the trend will be slower than before 2009.

Source: Economic and strategic research, Komerční banka; the Czech Statistical Office; Bloomberg; the Czech National Bank; Ministry of Labour and Social Affairs; Macrobond                                           

Note: (*) external trade as per cross-border statistics; (**) inflation components net of primary impact of tax changes