March brought some conflicting data for the CNB, but the hawkish reaction to the energy shock is evident
The Czech economy accelerated at the end of last year and maintained its inflationary bias due to strong household consumption and strong wage growth unsupported by productivity. However, the central bank's New Year communication hinted at a possible interest rate cut. However, this rhetoric has been changed by the recent energy shock. For the central bank, the dynamics of core inflation will be key in the coming months, but also the pass-through of higher oil and gas prices to other price segments in the economy. March price expectations rose, but their April perception will be more guiding for the central bank.
The Czech economy had accelerated by 0.7% quarter-on-quarter at the end of last year, slightly above the original estimates, and had maintained its inflationary bias. Growth was mainly driven by household consumption, but fixed investment also added to the growth. Unit labour costs continued to rise due to again stronger wage and salary growth amid a lacklustre trend in productivity (see here for more details), keeping potential inflationary pressures at bay, although there was also a slowdown in core services inflation in January and February. A possible upward break during March (but also April - a preliminary estimate will be available on 6 May, the day before the CNB meeting).
January data, on the other hand, showed a weakening in economic activity due to a slump in industry and construction, but core retail sales remain relatively resilient. This is despite a further rise in unemployment, which may partly reflect changes in legislation, and the labour market is likely to remain partly tight. In addition, wage growth, together with slowing inflation in January and February (averaging 1.5% y/y), is supporting a recovery in household purchasing power (see the report on household disposable incomesfor more on this). More detailed numerical dynamics of the Czech economy in January on the CBA Monitor - here, or the latest table below.
Added to this are the still resilient March purchase plans of consumers, but also industry. Although economic sentiment was already gathering during the period of higher oil prices, consumers (and not only them) were probably anticipating a more limited war with a short-term energy shock. This was probably matched by a limited rise in inflation expectations. Since this indicator will be key for the CNB, I constructed a composite index of price expectations relative to Czech inflation (see Chart 1 below) that could serve as a guide for the months ahead.
The newly constructed composite price expectations index for March suggests consumer inflation approaching around 3%. This is more or less in line with the current mechanical adjustments to the short-term outlook for consumer price growth due to higher fuel prices. These suggest a shift from February's CPI at 1.4% to 2% in March and 2.8% in April, with fuel adding around 1ppt to CPI growth while so far this year it has taken 0.3ppt out of it.
New credit growth remained strong in February, that is, for mortgages and home loans, while corporate loans weakened slightly compared to the second half of last year and were close to last year's average.
Even more important for the CBN will be the pass-through of these energy shocks into core inflation and the subsequent potential increase in the money supply (via bank lending or expansionary fiscal policy) due to less restrictive interest rates (so here we will compare the increase in inflation and wage expectations versus the yield curve). One of the key factors that will determine this pass-through is the anchoring of inflation expectations and labour market developments (employment and wage growth), or how expected economic activity, and hence expected real household incomes, will affect consumer acceptance of higher prices across the economy.
Although we can draw a parallel with the period of the start of Russia's invasion of Ukraine in 2022, some of the circumstances are the same (it is an energy shock) but in many ways they are different at present (the price scale of the shock particularly for gas and electricity, the extent of supply disruptions, the "sympathy" with higher prices among retailers affected by the covid vs. stronger real wage growth).
Main charts
Price expectations
Oil prices are also an inflation risk due to still elevated longer futures (bottom lines in chart)
Economic activity for January: weaker manufacturing and construction vs. resilient retail
Economic sentiment held for March, but was picked up during the first half of March - by then, oil prices had already gone to $100, but the shock was considered more "temporary"
New economy lending differs in the optics of lending to households and firms ...
... for which new koruna loans in particular did not build on the stronger figures of the second half of last year
About the prices
Industry unsurprisingly reacted fastest to the energy shock
Elevated price expectations in services may be risky for the central bank
The shock to gas and food prices will be more important for consumer inflation and the extent of its increase
So the food price model will become more important
... i.e. after the model of Czech fuel prices
Interest rates responded by rising across the region ...
... and across the yield curve
On economic sentiment
Employment expectations remained solid in March, in contrast to a gradual rise in unemployment
January data on (volatile) industrial wages may bring some relief after strong wage growth last year
Consumer plans remained high in March, but April will be more crucial for the central bank ...
... and the same goes for industrial sentiment, which has improved not only in our country
On economic activity
Retail sales maintained strong momentum ...
... which does not apply to the construction sector (at a time of weaker permits?), but also to industry, including manufacturing
...... where cars were resilient, but that was not the case for energy-intensive industries
While exports have held solidly
... but the foreign trade surplus has deteriorated slightly in recent months
