Tomsik Says Czech Rate Raise May Be Delayed by Euro Debt Crisis

The Czech central bank may be able to delay an increase in its interest rates as the euro-area’s debt crisis may keep the region’s borrowing costs lower for longer, Vice-Governor Vladimir Tomsik said.

Tomsik spoke in a July 25 interview on developments in the Czech economy and commented on proposed changes to the regulatory framework of the financial industry.

On growth and inflation:

“It’s evident that since the latest forecast from May, demand from Germany for Czech exports has been surprising on the positive side. Germany is growing more than Consensus Forecast initially predicted, therefore, the Czech GDP growth forecast for this year can be expected to be revised upwards.

‘‘The previous GDP forecast was for about 1.5 percent this year, based on an assumption, taken from Consensus Forecast, that the German economy will expand by about 2.5 percent. At present, Consensus Forecast shows Germany should grow almost by 3.5 percent this year.

‘‘Germany accounts for about half of Czech exports to the effective euro-area, which describes the main Czech trading partners in the euro zone.

‘‘As Germany is now forecast to grow one percentage point faster, that means the Czech economy should grow about a half-percentage point faster.

‘‘The question I’m asking is whether this higher growth is pro-inflationary or not. If it was pro-inflationary, then we would need to react. But it seems to me that up to now the main driver of GDP growth are net exports, which is supporting koruna appreciation and thus taming inflationary pressures. I don’t see domestic demand-driven inflationary pressure so far.

‘‘Wage growth in the Czech economy is under control and it corresponds to increasing labor productivity. The fact that wage growth is currently tamed is not that surprising because the crisis has diminished the cushion for the corporate sector and it doesn’t have financial resources for more significant salary increases.

‘‘So even when the GDP forecast is raised to about 2 percent for this year, I’m convinced that such growth would be below the potential output of the Czech economy. That’s why GDP growth isn’t creating inflationary pressures.

‘‘I personally expect that the inflation outlook, adjusted for the impact of the prepared changes to the value-added tax, will show price growth should be near to our inflation target.

‘‘Commodity prices are a shock reflected in the headline inflation rate, but core inflation still remains negative. The energy-price shock is beginning to gradually fade away, and food prices are also beginning to decrease.

‘‘If I see signals that the headline inflation rate, after the impact of the VAT increase, is influencing inflation expectations, then we would need to act immediately. But history has shown that previous VAT increases had very limited impact on inflation expectations. Our current surveys show that inflation expectations are so far very well anchored.

‘‘A VAT increase is primarily reflected in headline inflation, but it also reduces disposable income of households, and thus becomes and an anti-inflationary factor too.’’

On monetary policy and risk scenarios:

‘‘The most delicate task is to detect the turning point for monetary policy. At the moment, the turning point we are approaching is probably for higher interest rates, and now the debate is centered on finding this turning point.

‘‘Interest-rate differential is a very strong channel we include in our forecasts. The more important factor is that the differential between the market rates in the Czech Republic and the euro zone is much narrower than the spread between the policy rates.

‘‘Market rates are more important for the real economy, and euro-area rates are now significantly influenced by the current debt crisis. The Euribor is low, while there is still a risk premium in the Czech money market, so the differential between the market rates is not that wide as between the policy rates.

‘‘If the euro-area debt problems escalate and the outlook for market interest rates shows slower upwards dynamics than what would be natural for an economic recovery, then the resulting narrower interest-rate differential may be supporting for the koruna and tame inflation pressures in the Czech Republic.

‘‘On the other hand, an eventual weakening of the euro-area’s demand for Czech products would negatively affect our net exports, leading to currency depreciation and pro-inflationary pressures.

‘‘Uncertainties are great and the questions is which of these two channels of external risks will prevail.

‘‘Right now, I personally see weak domestic-demand pressures, GDP driven by exports and the lower path of euro-area market interest rates as key starting points for our forecast. The forecast for euro-area market interest rates moved downward already in the previous monetary policy meeting in June and the outlook has since moved even further downward. At present, it seems that the first channel, with the lower path of euro zone market interest rates, is materializing.

‘‘Growth in Germany is accelerating, but the market rates are affected by the debt problems in some euro countries and this has pushed the Euribor outlook down.

‘‘This may be one of the reasons for some delay in raising interest rates in the Czech Republic.

‘‘Until now, we have said the turning point may come in the third or the fourth quarter. The previous forecast showed the average market interest rates rising from the fourth quarter, which didn’t rule out raising the policy rate already in August. But in the current situation, when I consider the effect of the lower outlook for euro-area market rates, the turning point may be pushed back.

‘‘I can’t rule out the turning point will come this year. Nor can I rule out that it will come next year. With the degree of uncertainty we’re facing at the moment, nothing can be ruled out.

‘‘Investors appear to be noticing the developments with market rates in the euro area and market expectations of higher Czech interest rates have also moved downward to reflect that. The Czech forward rate agreements are now even below our previous forecast from May.’’

On financial regulation:

‘‘The key issue for us is that in a situation when the home and host regulators don’t agree on something, the power to decide isn’t given to the European Banking Authority.

‘‘Banks incorporated in the Czech Republic hold assets against liabilities formed by deposits of Czech depositors that are insured by the Deposit Guarantee Fund and effectively guaranteed by the Czech Finance Ministry.

‘‘It’s not possible for a supranational institution such as EBA to decide that, when needed, these assets, this liquidity, may be transferred outside without a proper compensation. We insist that this can only happen when both the home and host supervisors agree on such transfer. We need to see that the assets coming here are adequate and liquid, because if there is a problem, it will be the Czech state paying the bill for assets that may become worthless.

‘‘The main principle that must be respected is that the one who pays, must also have the decisive supervisory powers.

‘‘When you allow a split of the supervisory powers from the individual competent supervisor responsibility, you might not stop or eliminate the economic crisis, but paradoxically you may end up spreading the crisis further to other countries through the banking channel.’’

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