Czech Policy Makers Keep Record-Low Interest Rate on Inflation, Greece

The Czech central bank kept its benchmark interest rate at a record low for a 13th month as government spending cuts curb domestic demand and the euro area’s debt crisis is a risk to an economic recovery.

The Ceska Narodni Banka left the two-week repurchase rate today at 0.75 percent, a half-point less than the European Central Bank’s main rate, in line with forecasts of all 23 analysts in a Bloomberg survey. Five policy makers supported stable rates, while the remaining two board members voted for a quarter-point increase. The bank will publish individual votes in the minutes from the meeting July 1.

The Czech monetary authority has kept the main rate steady since May 2010 as central banks across Europe lifted borrowing costs to curb inflation. Poland increased its benchmark rate for a third month and the fourth time this year on June 8. Czech policy makers are weighing differing signals from the economy as output growth and headline inflation accelerated, while state spending cuts continue to hinder domestic demand.

“The question we are asking is whether growth is pro- inflationary or not,” Vice-Governor Vladimir Tomsik told reporters after the decision. “Because growth was driven primarily by net exports, the structure is not pro-inflationary. It’s not driven by domestic demand, which remains weak.”

Inflation accelerated to 2 percent in May, matching the central bank’s target, from 1.6 percent the previous month, driven mainly by higher food prices, the statistics office said on June 9. Housing and energy costs, as well as more expensive oil, also helped spur inflation above the central bank’s 1.7 percent forecast for May.

Government Austerity

Gross domestic product grew 2.8 percent in the first quarter on the year, compared with 2.7 percent in the final three months of 2010, with exports and a revival in investments contributing the most to the expansion. Household and government consumption declined as the Cabinet of Prime Minister Petr Necas trims state spending.

The Czech koruna was little changed at 24.358 to the euro as of 3:39 p.m. in Prague. The koruna has gained 2.7 percent to the euro since the start of the year, the second-best performance among more than 20 emerging-market currencies tracked by Bloomberg, after the Hungarian forint.

The main inflationary risks include current faster price growth driven by food costs, a possible revival in domestic demand and the government’s plans to raise the value-added tax from next year, Tomsik said.

The main anti-inflationary risks are a lower outlook for market rates in the euro area and the debt problems in some of the monetary-union members. Interest rates in the euro region are among the variables the Czech central bank applies in modeling its forecasts. It is currently using a forecast of the three-month Euribor at 2 percent next year, compared with the previous forecast of 2.6 percent.

“When it was communicated that the developments with Euribor rates is among the anti-inflationary risks, then, all things being equal, it may be expected that the path of Czech market interest rates may change in this respect,” Tomsik said.

The assumption of a gradual increase in market interest rates starting in the fourth quarter, included in the latest forecast from May 5, is still valid, Tomsik said.

Czech policy makers have shown differing views on inflation risks, with some central bank board members advocating higher borrowing costs. Eva Zamrazilova and Kamil Janacek voted for higher borrowing costs at previous meeting on May 5, while the remaining 5 policy makers voted for stable rates.

Export-Driven

The Czech economy is driven by foreign demand for its goods, including Skoda Auto AS cars, as exports account for about 70 percent of GDP. Companies also supply parts to German manufacturers, which then sell their products outside the European Union.

The economic recovery is facing risks of a potential negative impact of the-area’s sovereign debt crisis as Greece seeks to push through 78 billion-euro ($111 billion) of budget cuts to secure more international financial aid.

The International Monetary Fund, contributor of a third of bailout money for Greece and the two other euro-area countries that have received bailouts, Ireland and Portugal, has warned EU leaders that a failure to take decisive action on the debt crisis risks triggering “large global spillovers.”

The Czech central bank forecasts GDP growth of 1.5 percent in 2011. It sees the inflation rate at 2.2 percent in the second quarter of next year and at 2.1 percent in the third quarter, which is the boundary of what it calls the monetary-policy horizon.

Policy makers moved forward the timing of a rate increase to the fourth quarter from the first quarter in 2012, reflecting expectations of more monetary tightening in the euro area, the central bank said on May 5.

Forward-rate agreements locking in three-month interest rates in three months dropped to 1.38 percent from 1.42 percent before the news conference. The three-month Prague Interbank Offered Rate, or Pribor, was at 1.18 percent.

“Even with inflation currently a little higher than what the central bank expected, the Czech National Bank certainly has time to wait because demand-driven inflationary pressures are not appearing and the koruna is still relatively strong,” Michal Brozka, an analyst at Raiffeisenbank AS in Prague, said in a report.

To contact the reporter on this story: Peter Laca in Prague at placa@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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