• Economic growth is `pleasant,' but inflation remains subdued
  • Euro area, impact of ECB `crucial' to future Czech policy

Czech rate setters may be forced to not only prolong their loose policy regime but to also ease monetary conditions further if pressures from the euro area continue to undercut inflation, central banker Lubomir Lizal said.

With the country’s fastest pace of economic growth in seven years failing to spur price growth, the Prague-based central bank is debating how long it will need to maintain its mix of near-zero interest rates and a cap on gains in the koruna. The bank has pledged to keep the koruna from appreciating past “around” 27 against the euro at least until next July, with some rate setters suggesting that could extend to beyond 2016.

Lubomir Lizal
Lubomir Lizal
Source: Czech National Bank

“For me, the question might not be whether to keep the current policy longer, but whether we will also need to take some kind of measure to loosen it further,” Lizal said in an interview in the central bank’s offices in Prague. “If we are in a situation when the outside environment is disinflationary and the impulses are in a negative direction, then I think the policy will have to be looser than it is now.”

Czech rate setters are struggling against a slowdown in inflation, a task complicated by global oil prices that are hovering near a six-year low and the continued pursuit of loose monetary policy in the euro zone, the country’s largest export market. The Czech central bank has repeatedly postponed its forecast for reaching its 2 percent inflation target since it introduced the cap on koruna gains in November 2013.

Czech central bank has repeatedly postponed forecast for inflation returning to target.
Czech central bank has repeatedly postponed forecast for inflation returning to target.

The koruna traded 0.1 percent weaker at 27.07 against the euro at 10:47 a.m. on Tuesday, according to data compiled by Bloomberg. The koruna has strengthened 1.5 percent against the common currency this year, outperforming its regional peers the Polish zloty and Hungarian forint, which have lost 4.2 percent and 2.5 percent, respectively.

Inflation slowed for a second month in August to 0.3 percent from a year earlier, compared with 0.5 percent in July. At the same time, gross domestic product unexpectedly accelerated to 4.4 percent in the second quarter from the same period in 2014, the strongest since 2007.

“The real economic development is quite pleasant,” Lizal said. “What is less pleasant for the central bank is what’s happening with inflation. The developments abroad are again creating disinflationary risks, which is a little bit of a problem.”

The central bank cut the inflation forecast to 1.6 percent for the third quarter of 2016, from 2 percent, and it sees price growth at 1.8 percent in the last three months of next year, according to its latest outlook published on Aug. 6. Inflation won’t return to the bank’s 2 percent target in the next 12 to 18 months, according to the forecast.

Next Forecast

If the bank’s forecast fails to show a credible path reaching the inflation target on the policy horizon, that’s when Lizal said he would start considering further easing. The next forecast may show “a lot” about the outlook if there are significant revisions regarding the developments in the euro area, he said.

Further loosening by the European Central bank’s quantitative easing program and the price developments in the euro area have also deterred the effect of Czech monetary efforts on prices, according to Lizal.

After the ECB has cut its outlook for inflation and growth for each year through 2017, Governor Mario Draghi unveiled a retooling of the quantitative easing program and signaled policy makers may expand stimulus if the rout on financial markets continues to weigh on growth and inflation.

As the ECB’s policy has become more relaxed, the Czech regime has relatively tightened, even if it hasn’t changed, Lizal said.

“There’s a profound conflict now between how the domestic economy is developing and the effects and risks coming from abroad,” Lizal said. “Right now, I believe that the external factors, such as the future of the ECB’s QE program, may be quite crucial for what’s going to happen.”

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