Czech Central Bank Signals May Cut Further After Pause

The Czech central bank kept interest rates unchanged today, after reducing borrowing costs for the first time in two years in June, and signaled it may continue with monetary-policy easing as economic outlook worsens.

Policy makers held the two-week repurchase rate at a record-low 0.5 percent, a quarter-point below the European Central Bank’s main rate, in line with the forecasts of 19 of 20 economists in a Bloomberg survey. One predicted a reduction to 0.25 percent. Four policy makers voted for stable rates, while two sought a quarter-point reduction, Vice-Governor Vladimir Tomsik told reporters in Prague today.

The Czech central bank cut borrowing costs on June 28, a week before the ECB, to ease conditions in reaction to a worsening economic outlook. The bank revised its gross domestic product forecast for this year and cut the outlook for 2013, expecting measures aimed at curbing the budget deficit, including higher taxes, to further damp domestic demand. The economy already contracted for two consecutive quarters.

“The new forecast is consistent with a decline in market interest rates in the next several quarters, and their increase in 2014,” Tomsik, one of four board members to back the June cut, said. “Even as the bank saw balanced risks, it decided not to lower rates, a step that would be in line with the forecast, because the majority decided to wait-and-see.”

Bonds Rally

Czech bonds rallied after the central bank published the vote result and presented the new forecast with the rate outlook. Yield on the two-year government bond fell seven basis points, or 0.07 percentage points, to a record low of 0.738 percent at 3:25 p.m. in Prague.

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. Parliament on July 13 approved new measures, including an increase in the sales levy and a new income tax for higher earners, to cut the fiscal gap below the European Union’s limit of 3 percent of GDP next year.

The bank changed its GDP forecast to a 0.9 percent contraction in 2012, from a previously seen stagnation. It cut the 2013 economic growth estimate to 0.8 percent, from 1.9 percent. The central bank forecasts headline inflation at 2.3 percent in both the third and fourth quarters of next year.

Inflation Deceleration

Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, will decelerate below the 2 percent target near the end of this year or beginning of 2013, Tomsik said.

The bank forecasts private demand to continue falling and negatively affecting the entire economic performance, with the only positive contribution coming from exports. “The forecast of a 1.5 percent decline in household consumption this year would be one of the sharpest decline in private consumption in the history of Czech Republic,” said Tomsik.

Central bank Governor Miroslav Singer, who secured a majority of the seven policy makers for a reduction after being outvoted in his attempt to cut rates in May, didn’t attend the session today, the bank said.

Economic Recession

Economic output fell 0.8 percent in the first quarter from the final three months of 2011, the second contraction in as many quarters, as households curbed spending in response to a worsening economic outlook across Europe. The economy relies on demand for cars, auto parts and electronics goods from the EU, the market for about 80 percent of Czech exports.

The inflation rate rose to 3.5 percent in June, from 3.2 percent in the previous month. The reading was 0.1 percentage point lower than the central bank forecast. Inflation relevant for monetary policy was at 2.2 percent.

Czech central bankers supporting the cut 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 has exceeded its 2.5 percent target since October 2010.

Decisions on interest rates are influenced by koruna moves. A stronger currency tames inflationary pressures while a weaker one makes imports more expensive, which may stoke price growth. The central bank expects the koruna to strengthen “very moderately,” according to the new forecast.

“There is no recovery in the Czech economy,” Danske Bank AS said in a report today. “Indeed, it looks more like the Czech economy is falling deeper into recession, and unfortunately neither the Czech government, nor the Czech central bank has done much to improve the situation.”

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