MACROECONOMIC FORECAST OF THE CZECH REPUBLIC 1Q 24

Prague, 15 February 2024 - The chief economists of the banks represented in the forecasting panel of the Czech Banking Association (CBA) expect the domestic economy to grow by 1.2% this year and have thus lowered their estimate compared to November last year. For next year, on the other hand, they have revised growth towards stronger values and expect 2.8% growth. The change in economic growth estimates towards weaker figures for this year is attributable to a slower recovery in household consumption and weaker external demand. Average inflation will fall to 2.7% this year, before falling further to 2.2% next year. Nominal wages will rise by around 6.5% this year and by less than 4% in real terms, marking the first real wage growth after a two-year hiatus. The labour market has been affected only to a limited extent by last year's economic downturn and the unemployment rate remains at low levels, although some signs of a cooling in the labour market are already visible. CNB interest rates will continue to fall, with the CNB base rate expected to reach 4% this year and close to 3% next year. The koruna exchange rate should be close to CZK 24.7 per euro at the end of this year, with the koruna strengthening slightly further next year;

Uncertainty in global developments persists

In some respects, global economic developments have remained unchanged since the last forecast in November. The US economy continues to perform well above expectations, while the euro area figures tend to be less favourable and economic growth estimates are revised lower. In particular, the weaker outlook for the industrial and export-oriented economies, especially Germany, whose economy is expected to stagnate this year according to some estimates, is a source of uncertainty. Since last October, the market has noticeably reassessed the pace of interest rate cuts by major central banks in light of the faster decline in inflation. Although estimates of the start of rate cuts by the ECB and the Fed have been changing gradually, the panel's economists expect it to start in the middle of the year. The escalation of geopolitical risks in the Middle East has so far not caused a more noticeable rise in commodity prices that could slow or completely disrupt the ongoing disinflationary process, although risks remain elevated in this regard, especially in the context of rising shipping prices;

"The domestic economy will grow only slowly this year and its expected growth this year has fallen to 1.2% compared to the previous forecast in November. One of the reasons for this is the continued weakness abroad, especially in Germany, which, like the domestic economy, is affected by high sensitivity to foreign trade, the high energy intensity of industry and the pessimism of households, which have significantly reduced their consumption as a result of rising costs over the past two years," says Jakub Seidler, chief economist at the Czech Banking Association.

Cautious recovery this yearThe new CBA forecast for this year revised the development of the domestic economy towards only moderate growth. While growth of less than 2% was expected for this year during the autumn, weaker growth of 1.2% is now estimated.According to the preliminary GDP estimate for Q4, although the domestic economy was already growing at the end of last year, cautious prospects for the upcoming development still prevail. The risk is mainly related to the slow recovery of external demand, which will hamper the take-off of domestic industry and exports. The latter was strongly driven by car production last year, but it is already close to its peak and will not give the domestic economy as strong a growth impulse this year as last year. The first half of this year is therefore unlikely to bring any significant signs of improvement, and the forecast expects a slight acceleration in quarter-on-quarter GDP growth only in the second half of the year. Next year, economic growth will pick up and should be slightly below 3%;

"The Czech economy can count on some recovery in household demand thanks to the fall in inflation. However, how much GDP growth the Czech Republic will achieve this year will also depend on when there is an improvement in export demand, i.e. when growth will get on the other foot," says Pavel Sobíšek, Chief Economist at UniCredit Bank

The forecast assumed that economic growth would be driven mainly by domestic demand. Household consumption should start to grow again, by 2.5 %, after a decline in the previous two years. This is slightly weaker than expected in the previous forecast, as household confidence remains low and the start of consumption may be delayed. At the same time, expected real wage growth of less than 4% this year is confronted with the impact of the consolidation package, which will dampen the positive effect of wage growth on household net incomes. We expect consumption growth of 3 % next year, which was common in the pre-pandemic era. Government consumption is expected to grow at around 1.5% this year, i.e. at half the pace of the previous year due to the consolidation package. Investment will grow by 2.6 % this year due to lower interest rates and the continued need to invest in energy conservation. A significant uncertainty will be the recent volatility in inventories, which is expected to dampen growth this year due to a reduction in previously accumulated inventories. Given weaker developments abroad, export growth is expected to be weaker than in the autumn forecast. The automotive sector was also a major contributor last year and will not be able to maintain similar growth rates this year.

Labour market starts to cool down slightly, but the share of unemployed persons will increase only slightly this year

The domestic labour market remains in good shape in the context of economic developments and the unemployment rate is the lowest in the EU. The overall share of unemployed persons reached 3.6 % in 2023 and is expected to rise only slightly to 3.8 % this year. However, this is still lower than what was observed in 2017, when the domestic labour market was already showing signs of overheating. Thus, the slight rise in unemployment can be interpreted more as an easing of the acute overheating. Although January's rise in the share of unemployed persons to 4 % was mainly driven by the traditional seasonality of the winter months, slight signs of cooling are nevertheless visible on the labour market, as confirmed by leading indicators or the fact that employment in industry has fallen by almost 2% over the past year.

Nominal average wage growth will reach 6.5 % this year, and nominal wage growth should reach 5 % next year. After two years, real wages will thus start to rise again, but given the decline in the last two years, they will remain roughly at the 2018 level. Next year, real wage growth should continue, but still at a relatively moderate pace of around 3%. According to the current outlook, real wages will not surpass their current peak level of 2021 before 2027.

Average inflation to fall to 2.7% this year, to reach almost 2% target next year

After two years of average double-digit inflation, price growth should slow noticeably this year, bringing inflation to an average of 2.7%. Compared to the previous forecast, the figure has increased slightly due to higher administered price growth, but expectations of a disinflationary process are otherwise unchanged. Although the full-year outlook for inflation will largely be determined by January inflation itself, which will be published after the conclusion of this forecast, the consensus of economists expects the January rate to be slightly below 3%. For next year, then, average inflation is estimated at 2.2 %. Although upside risks to inflation have not entirely disappeared, domestic ones have declined compared with the end of last year. On the other hand, there are still some difficult-to-estimate risks associated with the war in Ukraine and, more recently, in the Middle East. The disruption of the Red Sea shipping route has already led to a sharp increase in shipping prices in this area and may thus slow down the disinflationary process in some parts of the world.

"The period of high inflation is over, and with it the period of relatively high interest rates. There is a good chance of achieving the 2% inflation target on a sustainable basis at the start of next year. In addition to energy prices, the complicated situation in international shipping is also an inflation risk," says Petr Dufek, chief economist at Banka CREDITAS.

CNB to continue cutting rates, its main rate to fall to 4% by year-end

The Czech National Bank cut rates by half a percentage point to 6.25% in February, mainly because it believes that January inflation will be around the 3% threshold and that it is therefore possible to start easing monetary policy more quickly. The rate cuts will continue this year, although analysts, unlike the market, believe that the fall in rates will be milder this year than market rates suggest, mainly because of the weaker fall in core inflation. Thus, the consensus fairly uniformly sees the CNB's main rate at the 4% threshold at the end of the year, and slightly above the 3% threshold at the end of 2025. Despite the relatively rapid decline in CNB rates, the forecast does not foresee long ten-year rates falling more sharply, with their average value falling to 3.8 % this year and 3.7 % next year.

The exchange rate of the koruna was revised slightly towards weaker levels in the new forecast. At the end of this year, the forecast panel estimates it at around CZK 24.7 per euro. Compared to the current level of the exchange rate above CZK 25 per euro, the forecast still assumes a return of the koruna to a stronger level, which is mainly due to the expectation of a more modest decline in CNB interest rates compared to current market expectations. Next year, according to the forecast, the exchange rate will strengthen towards CZK 24.2 per euro. However, the dispersion of exchange rate estimates for next year remains considerable, as in earlier forecasts, and ranges from CZK 23.5 to CZK 25 per euro.

The consolidation package brings this year's budget deficit to GDP below the desired 3%

The CBA forecast estimates the government deficit for this year at 2.7 % of GDP, which will reduce the deficit by almost 1 pp compared to the previous year. The decline in the deficit this year is due to a combination of the unwinding of one-off expenditures related to compensating for high energy prices, a slight recovery of the domestic economy and the impact of the consolidation package. The domestic economy was facing significant fiscal imbalances and the consolidation package presented is a necessary condition for a more sustainable trajectory of public finances. The deficit for next year is estimated to be close to the 2% level, which will mainly be the result of the expected faster growth of the domestic economy.

Credit market developed mixed last year

The mortgage market bottomed out in the second half of 2022 and started to recover slightly last year. For the full year 2023, it declined by a quarter year-on-year, driven by the effect of the high benchmark base from the first half of 2022.The benchmark base effect is currently working in the opposite direction, with year-on-year growth in new mortgage originations close to 100%, which is also true for January's data. This year, mortgage activity should pick up again after two years, supported by continued declines in mortgage rates in addition to pent-up demand. The scope for a faster reduction this year is mainly due to the evolution of market interest rates for longer maturities, which have reacted to the change in market expectations for faster interest rate cuts by central banks this year.

In contrast, the volume of newly granted consumer loans in 2023 increased by 11 % and exceeded the CZK 100 billion mark for the first time. The average interest rate was slightly below 10 % at the end of last year, where it remained for almost the whole of last year.

New koruna loans to businesses fell by a third year-on-year last year, with koruna loans falling by 38 % and euro loans by 27 %. The share of new euro-denominated corporate loans in 2023 slightly exceeded the 50 % mark for the first time (51.3 %), while in 2022 it was 47.4 % and the 2014-2021 average was around 30%.

The CBA macroeconomic forecast in figures:

Indicator	2023	2024	2025
Indicator
Real GDP growth (%)	-0,4	1,2	2,8
Household consumption growth (%)	-3,2	2,5	3,3
Government consumption growth (%)	3,4	1,4	1,4
Investment growth (excluding inventories, %)	2,5	2,6	3,4
Export growth (%)	2,6	2,5	4,3
Import growth (%)	0,2	2,1	4,6
Inflation rate: CPI (%) average	10,7	2,7	2,2
Inflation rate: CPI (%) end of year	6,9	2,8	2,1
Percentage of unemployed persons (MPSV): average (%)	3,6	3,8	3,6
Average nominal wages (růst v %)	7,6	6,5	5,1
Average real wages (%)	-2,8	3,7	2,8
Government deficit/surplus (% GDP)	-3,6	-2,7	-2,1
Government debt (% GDP)	43,7	45,0	45,4
CNB 2T REPI base rate (%): end of period	6,75	4,00	3,25
3M-PRIBOR (%): average	7,12	5,30	3,70
10 Year Government Bond Yield (%): average	4,50	3,83	3,73
ECB base rate (%): end of period	4,50	3,50	2,75
Exchange CZK/EUR: average	24,00	24,80	24,47
Exchange CZK/EUR: end of year	24,70	24,67	24,23
Real GDP growth in the Eurozone (%)	0,5	0,5	1,4
Oil prices (USD per barrel): brent average	83	84	82
Growth in bank loans to customers (%)	5,9	5,8	5,5
Growth in bank loans to households (%)	4,8	5,4	5,7
Growth in bank loans to (non-financial) corporations (%)	4,7	5,5	5,6
Growth in total bank customer deposits (%)	7,9	6,6	5,4