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Czech Policy Maker Sees Debate on Rate Increase After June

The Czech central bank should consider increasing interest rates for the first time in four years after June as price growth exceeding its target may boost inflation expectations and wage demands, a policy maker said.

The Prague-based Ceska Narodni Banka has left the two-week repurchase rate at a record-low 0.75 percent, a quarter point below the European Central Bank’s main benchmark, since a cut in May 2010. While the central bank doesn’t react to price spikes fueled by government measures, it should stop them from boosting inflation expectations, board member Kamil Janacek said in an interview yesterday.

Borrowing costs have been steady as the economy slid into recession in the second half of 2011 and an increase in the value-added tax at the start of this year drove inflation to the fastest pace in more than three years. One of seven rate-setters, Eva Zamrazilova, voted for a quarter-point increase at the last meeting on March 29.

“I’m not saying we will change rates for sure, but it’s clear that the discussion about trends in inflation expectations will be more dominant in the second half of this year, mainly in the fourth quarter,” Janacek said, declining to say how he will vote at the next meeting on May 3. “And, as a result, there will be a discussion on whether the time has come to react by increasing interest rates.”

Forward-rate agreements fixing the three-month interbank rate in nine months rose to 1.23 percent today from 1.03 percent on Feb. 2, when the central bank’s forecast signaled interest rates may decline later this year. The three-month interbank offered rate, or Pribor, was 1.25 percent. The koruna extended its gains after Janacek’s comments, trading up 0.7 percent against the euro at 24.743 as of 3:55 p.m. in Prague.

Growth Prospects

Policy makers across Europe are weighing economic-growth prospects against inflationary pressures amid the continent’s sovereign-debt crisis. Hungary kept its two-week deposit rate at 7 percent for a fourth month yesterday. Romania’s central bank has cut the benchmark interest rate four times since November to 5.25 while Poland left its main rate at 4.5 percent for a 10th month on April 4.

The economy, which exports about 80 percent of its output, contracted in the third and fourth quarters of 2011 as government spending cuts outweighed demand abroad for Czech-made vehicles, car parts and electronics goods. The inflation rate rose to 3.8 percent in March, exceeding the central bank’s 2 percent target for a sixth month.

Inflation Forecast

The bank forecasts the inflation rate above 3 percent this year, before falling to 1.5 percent in the first quarter of 2013. Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, was 2.7 percent in March, the central bank said. It sees monetary-policy inflation moving “near” the 2 percent inflation target by the third quarter of 2013.

“There is a prevailing agreement within the bank board that the domestic demand is not a pro-inflationary risk at the moment, but the question is how long will this last and how quickly it can change,” he said. “Provided that the VAT rates rise again at the beginning of 2013, the question is whether this time it doesn’t push these inflation expectations up.”

The bank’s inflation forecasts may change with the government of Premier Petr Necas planning to push through another increase in the value-added tax rate as of 2013 as part of measures to cut the public-finance deficit below the European Union’s limit of 3 percent of GDP.

‘Well Anchored’

While outlook for future price growth is “well-anchored” now, a second VAT increase in as many years would be a “new situation for developments with inflation expectations, and a new challenge for monetary policy,” said Janacek.

Gross domestic product shrank 0.1 percent in the last quarter of 2011, the same as in the previous three months, according to statistics office data. The country ships about 70 percent of its exports to the euro area’s 17 members, with Germany taking the largest share, and exports will probably stay the sole contributor to GDP growth this year, Janacek said.

“We can’t expect domestic demand, households, government and investments, to contribute to gross domestic product growth this year,” he said. Households tend to increase savings in “uncertain times,” while the government is cutting spending and companies that don’t have enough export orders are cautious to invest, Janacek said.

Wage negotiations for next year will be an indication of whether the current higher price growth is spilling into inflation expectations in the economy, Janacek said. Skoda Auto AS, the unit of Volkswagen AG and the largest Czech manufacturing company, agreed to raise salaries by 5 percent for the year ending March 2013.

“Nominal wage growth of 4 or 5 percent and more, across all sectors of the economy, could be risky in the current situation of anemic economic growth,” Janacek said. “It would mean a relatively rapid increase in unit labor costs, which could negatively affect competitiveness and create demand-driven pressures.”

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