Czech National Bank preview: How to change the market’s mind

The Czech National Bank's monetary policy meeting will take place on Thursday next week and a rate change is not on the table this time either, in our view. However, we think it should be one of the most interesting sessions this year. Firstly, rapid disinflation opens up the question of a first rate cut; secondly, the record weak koruna in turn raises the question of intervention and postponement of rate cuts; and thirdly, the CNB will release a new forecast that may be the central bank's last attempt to reverse very dovish market expectations.

Since the decision itself does not have much potential to surprise, the main focus will be on the governor's press conference and the new CNB forecast. While it cannot be ruled out that some members will still vote for a rate hike, our baseline scenario assumes a unanimous leave rates unchanged decision.

The outlook for the economy should be revised down given that economic and wage growth surprised to the downside in the first quarter. On the other hand, headline inflation surprised to the downside in the second quarter by 0.4 percentage points on average and core inflation by 0.5pp. So together these should imply a slightly downward change in the inflation profile. The koruna on average was broadly in line with the CNB's forecast in the second quarter and we assume that the current record weaker levels will not be included in the new forecast due to the data cut-off. We can also see a big change in the forecast on the assumptions for the external environment, particularly on producer prices to the downside and the European Central Bank rate to the upside.

This mix should result in a big revision to the interest rate path in our view. The current forecast implies roughly 150bp of rate cuts this year. We expect the forecast to continue to imply rate cuts but in significantly smaller volumes. We can also expect alternative scenarios, which the board has been keen to show its preference for over the official staff forecast in recent months.

The current inflation trend opens the question of the first rate cut, which will be the main topic of the CNB meeting for the markets next week. Our forecast remains unchanged, i.e. a first rate cut of 25bp in November. However, the inflation profile is very tricky and in addition, the current weakness in the CZK may also be a problem for the board. Thus, we see a risk of delaying this move until the first quarter of next year.

Inflation is expected to fall close to 7% year-on-year in September, according to our forecast, however, the base effect will turn against the CNB in October due to the government measures last year. Thus, we could see prices jump back to 9% in October despite essentially month-on-month price stability, and remain around 8% by year-end. On the other hand, for January, we expect inflation to fall into the 2-3% range thanks to the base effect from this year and the signicant repricing of energy prices. In addition, newly, the energy companies in the Czech Republic will allow fixed contract customers to switch to lower prices below the government's cap in January, which should facilitate the transmission of lower energy prices into the CPI.