CNB preview: Rates set to stay on hold as Hormuz bites

Czech policymakers will likely keep the policy rate unchanged at 3.5% at next Thursday’s meeting, though inflation has picked up and is set to increase further. The current turmoil in the Middle East will have twofold implications: higher prices on the one hand and weaker global economic performance on the other. The CNB knows the basic macroeconomic business rather well and finds itself in a relatively comfortable situation vis-à-vis the negative external supply shock, which allows it to wait things out as long as it can to see how the various effects compound.

As Jakub Seidler puts it: “I can still imagine that we will get through the current situation without the need to increase rates.” A call for restraint echoes across the board, for example with Eva Zamrazilova: “Rates are where they should be and have a real positive return. So, we really don't have to rush.” We are very much aligned with this way of thinking, as this type of negative supply shock is in essence beyond the CNB’s control, and central banks should ideally look through the current volatility as much as possible.

We have updated the Czech inflation path, the key macroeconomic variable for a forward‑looking central bank’s monetary policy. We currently assume that the conflict in the Middle East lasts until June in the baseline scenario, with Brent crude monthly average prices remaining at USD 104/bbl until that time. From July onwards, the situation may calm down, with Brent crude receding gradually to USD 82/bbl by November. A similar path is assumed for natural gas prices, while the koruna is expected to be weaker from May onwards compared with our previous forecast.

This assumes the conflict lasts two months longer than in our previous forecast, pushing average headline inflation to 2.4% this year and 2.6% next year. In such conditions, core inflation would average 3% this year and 2.6% next. Headline inflation is set to peak at 3.6% early next year with the core rate at 3.3%. I assume that the CNB would do the right thing and refrain from touching rates, given this is a negative external supply shock, and pressure for economic activity will follow suit.

Should the conflict drag on till the end of the year, and Brent crude crawl to a monthly average of USD 107/bbl in December, more non-linearities would kick in, while headline inflation would average 2.7% this year and 3.1% the next. Core inflation would average 3.1% this year and 2.8% the next. In such a case, the situation becomes more complicated for the CNB, as headline inflation would peak at 4.8% early next year and the core rate at 3.7%. Some members would likely vote for a hike to confirm the hawkish talk. However, economic growth would likely slow down to some 0.1% quarter-on-quarter in some periods. We therefore expect only a cosmetic hike from September onwards, signalling that actions can follow words. This would require a delicate balancing act in communication and forward guidance.

Czech real GDP gained 0.2% QoQ in the first quarter, according to preliminary estimates, implying 2.1% annual growth. The quarterly expansion was positively affected primarily by growing gross capital formation, yet we assume that an increase in inventories made a considerable contribution. We expect that firms will postpone or alter their investment plans due to increasing energy prices and uncertainty in the coming quarters, but let’s wait for the 1Q26 detailed breakdown. The foreign trade balance made a negative contribution to quarterly GDP growth. Such an outcome aligns with the quarterly increase in gross value added being driven by the service sector, while industry recorded a negative impact. Employment remained unchanged in quarterly terms and added 0.7% from the previous year.

The reading came in well below market expectations, as Hormuz is likely starting to bite. This is consistent with our position that the Middle Eastern turmoil will have tangible negative consequences for economic activity. We just didn't assume such a stark impact would be felt so soon. Still, we must wait for the expenditure breakdown to proceed with a solid analysis. Overall, we maintain our position that the current negative supply shock will have tangible implications for the global economy, and we still believe that most institutions are underestimating the pressure. Taking on board the latest GDP figure, we lower our Czech economic expansion pace to just below 2% this year and to 2.3% next year in the base case scenario. However, in the adverse scenario, GDP growth might only reach 1.5% this year and 1.4% next.

With Czechia representing an industrialised, energy-intensive, export-driven economy, this is not good news either right now or when looking ahead. The European Commission president's observation that the cheapest energy is unused energy is peculiar to put it mildly, as opportunity costs should always be at the top of policymakers' minds. I believe that the opposite is ultimately true. If you cannot proceed as usual in tough times, you only demonstrate your weaknesses, and your competitors will eat you alive. The old saying holds for Europe once again: Vanitas vanitatum et omnia vanitas.

For sure, the CNB is an experienced institution and knows how to proceed lege artis during an external negative supply shock, which is far beyond its control. We will hear plenty of hawkish talk around an unchanged base rate, as nobody wants to push the economy to its knees. A silver bullet of a single hike would show that policymakers are prepared to walk the walk and back hawkish rhetoric with action, with words doing most of the work until late in the cycle. In an adverse scenario, policy could take on a full‑metal‑jacket stance in terms of holding the line. Should the European Central Bank give in to temptation and enter the waters of a potential monetary policy mistake by raising rates ante portas, the CNB is not likely to follow suit.