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Czechs Need Bold Action to Avoid Deflationary Trap, Danske Says

The Czech central bank needs to take bold monetary-policy easing steps and weaken the koruna to avoid a Japanese-style deflationary trap, Danske Bank A/S said.

Policy makers were split at their last meeting on Aug. 2 in assessing the effect of government tax increases on inflation and risks stemming from the euro-area debt crisis. Two rate setters sought a quarter-point reduction after the bank cut its two-week benchmark to a record-low 0.5 percent in June, while four voted for no change even as the bank’s forecast saw lower rates amid a worsening economic outlook.

The central bank should move beyond rate cuts and apply non-standard measures, such as buying assets like government bonds or selling the koruna on the foreign-exchange market, Lars Christensen, Danske’s chief emerging-markets analyst in Copenhagen, said in a report dated Aug. 20. The Czech economy has shrunk for three consecutive quarters and the central bank sees a full-year 0.9 percent contraction this year.

Weakening the koruna “is probably easier for the central bank to implement and it wouldn’t dramatically change the day-to-day operational framework of Czech monetary policy,” Christensen said in the report. “A devaluation of at least 20 percent to around 30 koruna per euro from the present levels is likely to be needed” to curb disinflationary pressures by increasing money supply, he added.

Inflation is fueled by tax changes, following an increase in the value-added levy at the start of 2012, the impact of past koruna depreciation and commodity costs, while consumer demand isn’t pushing prices up, central bank Vice-Governor Vladimir Tomsik said in an Aug. 15 interview.

The inflation rate has exceeded 3 percent every month this year, dropping to a seven-month low of 3.1 percent in July. Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, was 1.8 percent in July, below the central bank’s 2 percent target. It forecast policy inflation to decline below its goal at the end of 2012.

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