Czech: Central bank on hold amid global uncertainty

External headwinds appear to be driving the CNB's increasingly cautious bias, with the global environment still unclear. After soft real-data from the eurozone and Germany in the second half of last year (to some extent attributable to one off factors), this year’s indicators have failed to bring any comfort to the central bank. German and China manufacturing PMIs have fallen below the 50-point threshold, signalling a contraction. Czech leading indicators have moved in a similar direction, with the January PMI hitting a six-year low and falling to 49.

Arguments supporting a more cautious approach to monetary tightening persist, as suggested by new board member and former CNB Chief Economist Tomas Holub two weeks ago. He suggested that while the softer currency argues for further rate hikes, the worsening global outlook, together with anti-inflationary oil prices, argue against such a move.

The new CNB staff forecast should see downward revisions to GDP for 2019 and 2020, to below 3% from 3.3% in November. A tight labour market and solid wage growth suggest the new inflation report will forecast further inflationary pressures this year in terms of core inflation.

The recent deceleration in Czech CPI to 2% was mainly due to food and fuel prices. Importantly, December core inflation, as defined by the CNB, accelerated further to 2.6% year-on-year, as did prices of services (3.4%), up 3% YoY for the whole of 2018. Core inflation growth should remain strong this year, though headline inflation will be revised downwards from 2.6% towards 2.1% due to oil price developments.

With an uncertain global environment and headline CPI on target, the CNB should stay on hold this week (though further implicit tightening is likely in the new forecast). We see scope for two CNB hikes this year but an improvement in the global economic outlook is now a necessary condition for further CNB tightening.