CNB likely to cut rates next week
Economic commentary by Jakub Seidler, Chief Economist of the CBA
The CNB will decide on monetary policy next Thursday and will also have a new macroeconomic forecast, but it should not undergo major changes compared to the previous one. Inflation developments so far suggest that January inflation itself could end up below the 3% threshold. This may eventually persuade the Board to cut rates more decisively by half a percentage point, although January inflation will not be officially published until a week after the meeting. A possible 50-point cut is also suggested by recent comments from CNB officials. Therefore, we believe that the chances of a half percentage point rate cut are currently higher than the option of a cautious move on the traditional Thursday. Analysts are torn between these aforementioned options, but the market rates are pricing in a 50-point rate cut.
The uncertainty of the January repricing led the CBR to cut rates only cautiously by a quarter percentage point at the end of last year so far. The central bank's own forecast for this year foresaw a noticeable decline in inflation (2.6% in 4Q24), see Chart 1, which would have allowed it to cut rates even faster (CNB 2T repo forecast: 3.4% in 4Q24), but the CNB Board took a more cautious approach. Firstly, because firms' inflation expectations for 2024 remained high, but also because the debate on the need to raise prices in the context of energy price increases intensified again towards the end of the year, fuelling uncertainty about the intensity of the expected decline in inflation. The fact that the Board had announced in earlier communications that it intended to "smooth" interest rates, i.e. not to raise them so high as recommended by the model, but then not to cut them immediately as recommended by the model, probably played a role.
Although after the December meeting itself, it seemed likely that the central bank would again adopt a cautious approach at its upcoming meeting in early February and cut rates only by the traditional quarter, as January inflation was not published by statisticians until a week after the meeting, developments in recent weeks have begun to change the situation.
This is mainly because the belief that January inflation will eventually be lower and may end up below the 3% threshold has grown noticeably. This is suggested by preliminary data on food prices, but also by other leading data or alternative indicators obtained by regularly monitoring prices from the websites of providers of goods and services. Weaker inflationary pressures are also indicated, for example, by the latest leading indicators from industry, where firms cut prices significantly in January due to weak demand, or by the first signs of January inflation from abroad, as well as by generally subdued economic activity.
This does not mean that inflation risks have disappeared, with slower fading inflation in services prices, for example (5.7% yoy in 12/23, Chart 2), but a slightly faster rate cut at the February meeting would not be wrong, even if the January inflation number itself is not as low after all as optimistic estimates suggest.
The market is aware of this fact, and a half percentage point rate cut is thus already priced into market interest rates (Chart 3, note: the difference between the 3M Pribor and the CNB's main rate is currently negative due to priced-in expectations of future rate cuts). This too could end up being another supportive argument for central bankers not to delay faster rate cuts until the end of March. Despite the stronger rate cut expectations, the koruna has weakened only marginally and is still below CZK 24.9 per euro and the average value for January is very close to the expected 1Q24 exchange rate from the latest CNB forecast, Chart 4. The possibility of a more significant rate cut was then mentioned in the media space by both Deputy Governor J. Frait and Councillor T. Holub.
The scenario of a rate cut by "half" now seems like a more likely outcome of Thursday's central bank meeting, although the decision may be close in terms of the debate at the board, and may again be unanimous in the vote itself.
CNB November forecast
Consumer prices (%, annualised, average)
Source: CNB, CBA
Core and service prices (% yoy)
Source: CSO, CNB, CBA
Expected development of 3M Pribor in 1 month (according to 1x4 FRA, %)
Source: LSEG, CBA
EUR/CZK, reality vs. CNB estimate
Source: LSEG, CBA