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Czech Central Bank Cuts Rate to Record Low on Austerity

The Czech central bank cut its main interest rate to a record low, the first change in two years, after faltering domestic demand sparked an economic recession and the government’s borrowing costs sank to the lowest ever.

The Prague-based Ceska Narodni Banka lowered the two-week repurchase rate by a quarter-point to 0.5 percent today, in line with forecasts of 20 out of 24 analysts in a Bloomberg survey. The reduction deepened the discount to the European Central Bank’s benchmark rate to half a percentage point. The move was influenced by government plans for more measures to cut the budget deficit, Governor Miroslav Singer told reporters.

“That would mean a further relative curbing of demand, which allowed us to ease the conditions,” Singer said.

As the ECB lifted and then lowered its refinancing rate by a half point to 1 percent last year, the Czechs had held steady since May 2010 because consumer spending wasn’t fueling inflation. Investors’ bets on lower interest rates pushed government bond yields to record lows and weakened the koruna, which headed for the biggest quarterly decline since the last three months of 2009.

Lower Yields

Falling interest rates helped push the yield on two-year government bonds to 0.9 percent, the lowest since at least 1997. The koruna traded at 25.744 per euro at 4:12 p.m. in Prague, 0.4 percent stronger from yesterday’s close.

Czech rate setters are assessing the impact of the government’s tax increases on shop prices and the effects of the euro area’s sovereign-debt crisis on the economy. At the previous meeting on May 3, the bank’s board split three ways over monetary-policy settings, with Governor Miroslav Singer and Vice-Governor Vladimir Tomsik voting for a rate cut, while four members wanted no change. One sought an increase.

The bank also lowered its Lombard rate by a quarter-point to 1.5 percent, while leaving the discount rate unchanged at 0.25 percent. Four policy makers voted for the cut today, while three wanted to keep borrowing costs unchanged. The bank will publish minutes from the meeting with the votes of individual board members on July 9.

Differing Assessments

Czech central bankers differ in their assessment of inflation trends from policy makers in Poland, the EU’s largest post-communist economy. The Narodowy Bank Polski was the only bloc member to increase borrowing costs this year as inflation exceeded the upper end of the target range since January 2011. Singer is discounting a spike in Czech inflation above the bank’s target in 2012, spurred by a tax increase and fuel costs.

The inflation rate dropped to 3.2 percent in May, the lowest this year, from 3.5 percent in April. The reading was 0.2 percentage point lower than the central bank forecast. Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, eased to 2 percent in May, matching the bank’s target.

Gross domestic product shrank 0.8 percent in the first quarter from the previous three months, after declining 0.2 percent in the final quarter of 2011. Consumer confidence fell to the lowest in almost 13 years in May, while retail sales declined 4.1 percent in April, the largest drop in two years and compared with a 5.5 percent increase in Poland.

Koruna Weakness

“Although the current weakness of the koruna speaks against lower rates, the Czech economic recession, amplified by the government’s savings measures, is a strong argument for lower interest rates,” Michal Brozka, chief analyst at Raiffeisenbank AS in Prague, said in a note after the decision.

Economic risks are moving toward the bank’s alternative economic scenario, which assumes lower monetary-policy inflation and interest rates next year, Singer said today.

It isn’t certain that the bank will further cut rates as signaled in the alternative outlook as koruna trends and developments in the euro area may influence the Czech economy, he said. The koruna has weakened 3 percent to the euro since May 2, one day before the previous policy meeting, the second biggest loss after Russian ruble among 25 emerging-markets currencies tracked by Bloomberg in that period.

No Guarantees

“I can hardly guarantee anything, the forecast is not an obligation for the central bank,” Singer said. “Overall, at this moment, I can only say I’m not that sure what it means for the future, and I think we will know more in the summer.”

Headline inflation may exceed the bank’s forecast of 1.5 percent in the second quarter of next year if the government pushes through another set of measures aimed at boosting budget revenue, including an additional increase in the sales levy and a new income-tax rate for higher earners, according to the central bank’s alternative outlook. A boost in taxes may further curtail consumer spending and limit demand-driven inflationary pressures, the bank said.

“Amid soft inflation and weak economic dynamics, we expect the policy rate to now be left unchanged through to end 2013,” Roderick Ngotho and Abbas Ameli-Renani, economists at Royal Bank of Scotland Group Plc, said in an e-mail. “While we do not think the MPC will cut policy rates any further, we remain mindful of the risks, especially given that there has been no suggestion from MPC members that a 0.5% policy rate marks an absolute floor.”

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