Czech inflation picks up yet food prices remain muted

Czech annual inflation quickened to 1.9% in March, driven by a surge in fuel on the back of the recent shock to Brent crude prices and stronger greenback. Consumer prices gained 0.6% from a month earlier for the very same reason, while both annual and monthly preliminary estimates for March came in marginally softer than market expectations. Overall inflation was held back by another monthly decline in food prices, reflecting the recent pronounced drop in agricultural producer prices. The benign dynamics in food prices should help to cushion the current global shock to energy prices and supply chains. That said, the government has started to take measures to mitigate the impact on fuel prices already.

Annual service prices picked up to 4.7%, while goods prices moved back to positive annual growth. With this, we estimate that core inflation either remained stable at 2.7% or marginally increased to 2.8%. We believe that there is a trade-off between the dynamics of various segments within the consumer basket, as the consumer disposes of a single budget that must be allocated to various needs and wishes. So, with the foresight of a general increase in energy prices, starting with fuel prices and ending with electricity prices for households, the average consumer will not be able or willing to spend resources in uncertain times on discretionary items. Let’s see how the budget constraint, potentially stretched with increasing energy bills, will affect spending on core inflation items.

Timing is extremely challenging in this matter, as households enjoyed a significant drop in bills for electricity and natural gas at the start of the year, due to previously subdued global energy prices and the government substantially reducing the regulated fee. Now, with the outlook for energy bills creeping up again, and a lot of uncertainty about the peak, we are likely to see weaker confidence take hold, followed later by tighter budget constraints becoming more binding. The question is when these effects will become tangible, and whether they will be strong enough to put meaningful pressure on service‑sector price dynamics and potentially bring them under control. In any case, second‑round effects are likely to push core inflation higher throughout the year, depending on how long elevated Brent crude and natural gas prices persist, alongside a potentially stronger dollar.

Real retail sales gained 4.1% YoY in February yet remained unchanged from the preceding month. Sales adjusted for price effects increased on an annual basis across the main groups, be it non-food goods, foodstuffs or fuel and beat expectations of market participants. Obviously, consumers were doing well before the onset of the Middle Eastern turmoil, so let’s see about the swiftness and strength of the confidence channel for the Czech spender.

With the elevated oil and natural gas prices having an upward impact on consumer prices over the coming months but also exerting a downward pressure on economic activity with some lag, the Czech National Bank can wait to get a better understanding of how the two effects compound. At the onset of a severe external supply shock, the appropriate response is not to change monetary policy hastily, provided the economic conditions allow for patience.

And honestly, this is precisely the situation facing the CNB, which can, for some time, sit on the couch and observe how developments unfold. Whether we see a hike or a cut first depends on inflation, the extent of damage to the global economy, the impact on Czech exporters, and the pace of deterioration in the labour market.