CNB cuts rates by half a percentage point as expected

Economic commentary by Jakub Seidler, Chief Economist of the CBA
CNB cuts rates by half a percentage point as expected ilustrační foto
At today's meeting, the CNB cut interest rates by 0.5 percentage point, which was in line with analysts' expectations. The CNB's main rate thus came in at 5.25% and is the lowest since April 2022 (Chart 1). Although inflation is already at the central bank's 2% target, the CNB is proceeding with more cautious rate cuts, as it has announced since the rate cut cycle began late last year. However, this is a predictable course of action in the context of recent market developments and the Fed's significant reassessment of the pace of rate cuts. Increased inflation in services also remains an uncertainty, which encourages cautious monetary easing not only in the Czech Republic but also in the US and the euro area. The market has been more in the thrall of global events in recent weeks and domestic interest rates on longer maturities have reached their highest level since late last year, which will leave room for mortgage rates to fall quickly despite today's CNB rate cut. 

Traditionally, today's central bank decision will have the fastest market impact on those products where interest rates are most closely tied to the CNB short-term rate, or 3M Pribor. As a result, we can expect a further decline in interest rates on corporate loans, where the average rate on koruna loans reached 7.3% in March, the lowest level since April 2022 (Chart 2). The interest rate differential between koruna and euro loans thus narrowed to just one percentage point in March, while it was still around 4 p.p. in the first half of last year and was most significant - even at over 6 p.p. - in mid-2022.

Interest rates on deposits will also fall in line with the decline in the CNB's main rate, as already indicated by the evolution of deposit rates with agreed maturity, both for households and corporates - these are currently the lowest since mid-2022 and have fallen by around one percentage point since their peak in the middle of last year (Chart 3).

For mortgage rates, today's central bank decision may not ultimately have any discernible impact - both this information is already contained in the longer rates, and these aforementioned rates have been noticeably affected by global developments in recent weeks, and in particular by the market's revised expectations for the speed of the Fed's rate cut. Longer interbank rates, which are key to mortgage rates, have risen by almost one percentage point in recent weeks and are thus at their highest level since late November/December last year (Chart 4). The trend of faster mortgage rate declines observed since the beginning of the year will thus be hampered despite today's rate cut by the CNB. In March, the average mortgage rate fell by two-tenths of a percent to 5.19%, the lowest level since June 2022 (Chart 5).
Updates after the press conference

The press conference after the CNB monetary policy meeting sounded hawkish, especially as the new interest rate trajectory had increased significantly in the new forecast. The forecast also expects more favourable economic growth this year and lower inflation. Governor Michl mentioned that the Board would proceed even more cautiously with further rate cuts, suggesting that a quarter percentage point drop in rates was more likely from the next meetings and that rates would remain stable at some meetings. At the end of the year, the market is now expecting a headline rate slightly below 4.5%, in line with the CNB's forecast. Thus, the market has returned to expecting higher rates for a longer period of time and the koruna reacted to today's hawkish press conference and forecast by strengthening below CZK 25 per euro.

The new forecast saw several changes, with more favourable growth expectations for this year (1.4% vs. 0.6% in the winter forecast) or lower inflation (2.3% vs. 2.6% in the winter forecast). These were largely anticipated by the market and analysts, as was the outlook for a weaker koruna (25 on average vs. 24.4 in the winter forecast). The bigger surprise for the market was the trajectory of the 3M Pribor rate, which was raised by 1.4bps for the end of this year, from 2.93 in 4Q24 to 4.28%. This is quite a noticeable increase, which was the main "hawkish" factor for the market (see table and chart 6).

Governor Michl confirmed that the model assumption of a neutral rate r* has not changed, the model still assumes this at 3% nominal (1% real rate and 2% inflation), and thus rates are headed towards this level in the forecast until the end of 2025. The Governor also mentioned again that the Board sees rates higher, at around 3.5%.

However, according to the Governor, the Board still assesses the risks of the forecast as slightly inflationary. The pace of further rate cuts will depend on the CNB's assessment of the inertia of the decline in inflation, the evolution of the koruna exchange rate and other macroeconomic data, including the labour market, fiscal policy and moves by foreign central banks. Governor Michl reiterated that the process of rate cuts may even be halted. 

What this implies: It is evident that the Board will prefer to cut rates further very cautiously - which is understandable not only in view of still elevated services inflation, but also the uncertainty of the ECB and especially the Fed rate path, where expectations have been significantly reassessed in recent weeks. Thus, a rate cut can be expected from the next CNB monetary policy meeting on a more traditional quater. Rates may then remain unchanged at some, probably at the September or December "small meeting" when the Board does not have a new forecast. That would take the CNB's main rate to 4.5% by year-end, which is roughly even current market expectations. They see the 3M Pribor rate at 4.3%, but there will still be a negative spread between the 3M Pribor and the 2T repo at that time (Chart 7). The CBR may then cut rates overall by one percentage point in 2025, taking them to the 3.5% level that the Board is also talking about by the end of the year.  Expectations of "higher rates for longer" have thus largely returned to the scene, which will put a brake on the current trend of accelerating mortgage rate declines.