Czech National Bank preview: Rate cuts coming into focus

The Czech National Bank will hold its monetary policy meeting on Thursday next week. In addition to the decision to raise interest rates, it will bring a new forecast - the first since the start of the Ukrainian conflict. It will see a massive revision in all directions. The CNB will basically have to halve growth projections for the external environment and double external price pressures compared to the February forecast. So, on the domestic front, we think GDP growth will be cut in half, implying about 1.5% for this year and a peak in inflation of just below 15% in May or June, which is in line with our view. So overall, we expect a massive upward revision to the interest rate forecast just on the merits of the CNB's macro model. According to our simulations, the peak in the key rate envisioned by the CNB could get as high as 7% in the second quarter with the aim of getting inflation to the 2% target by the middle of next year, which we think is unrealistic. We can also expect the model to inherently show rate cuts starting in the third quarter of this year, with a trajectory heading to the 3-4% range at the end of the forecast horizon, which will be difficult for the Board to communicate.

Almost nothing has changed in our view since the March meeting. The Board will remain more cautious relative to the staff's recommendations, which we believe will again recommend a 100bp hike or even more. However, we think the Board will find the best compromise to a 50bp hike, balancing the risk of stagflation and further inflation. However, we see a 75bp hike as an alternative scenario, especially after Friday's 1Q GDP release, which mitigates the risk of stagflation for the coming quarter. In our view, a 50bp hike next week would open the door to a further 25bp tightening in June and a terminal rate of 5.75%. In the case of a larger move, this could be enough for the Board to deliver the last hike in this hiking cycle next week.

However, we think the interpretation of the new forecast and communication of the next rate path will be the key story of this meeting. Given the massive rate hikes now and the early rate cut, we think the Board will take a smoothing approach, meaning smaller rate hikes now but a rate cut later versus the forecast, depending on the incoming data. We believe the Board will be reluctant to cut rates until the spot inflation rate falls visibly into the single-digit range, and given the potential upside surprises in inflation, we expect the Board to further delay rate cuts until at least the middle of next year.