The CNB's new outlook for higher rates "only" translated into hawkish communication
The CNB Bank Board unanimously left interest rates unchanged at 3.5% in the face of uncertainty over the Iranian conflict, although its new forecast suggests an increase to 4% this quarter. The decision is likely to have been driven by a combination of lower economic growth at the start of the year, which may have increased the weight of an alternative scenario with slower growth and lower rates. But probably also the fact that the baseline scenario with higher rates is only assumed for two quarters. It is therefore not surprising that the Board would want to have this monetary policy move sanctified by future developments. However, the latter may surprise with an inflationary development, of which a part of the Board is aware.
Governor Michl mentioned an alternative scenario with lower growth and interest rates as an answer to the question of why the CNB had not followed the new forecast, which brought the CNB interest rate closer to 4% by the second quarter of this year, while the previous forecast had worked with this level for 2027 because of stronger economic growth. Slower economic growth (see reports here and here and the second chart below) likely increased the weight of this alternative scenario.
At the same time, the new forecast looks out for a 4% interest rate "only" for two quarters. And it predicts a drop in the interest rate to 3.75% in the final quarter of this year and then to the current level of 3.5% at the end of the first quarter of next year. This seems to me to be too short-term a change in monetary policy settings in the current volatile world. And this is probably not only truefor this Board, but historically the Board has only proceeded to make similar short-term changes in monetary policy when developments are confirmed at the next meeting.
But the future risks are upside risks even with the end of the Hormuzblockade . Governor Michl mentioned that part of the Board is keeping the door open for a rate hike if there is a further pick-up in core inflation (see April inflation risks here) and/or higher energy prices seep through to the rest of the economy. The question on fiscal policy also came up. While the Governor did not mention lending to the government as an upside risk during the presentation, he did not omit looser fiscal policy and lending to the government and households as one of the upside risks in an economy with still strong wage growth (in services).
The CNB's new forecast is still looking for solid economic growth with a relatively modest acceleration in consumer inflation. In my outlook for today's decision, I had factored in a downgrade of the CNB's GDP growth outlook to 2.5% for this year and next, and similarly for the average inflation outlook. However, the CNB came up with a slightly more optimistic forecast with average GDP growth of around 2.6% with 2.3% average consumer price growth. This more moderate inflation growth reflects Brent crude oil at $85 this year and $76 next year, which therefore seems to anticipate an early end to the conflict.
The CNB will release details of the new forecast on Monday 11 May with the minutes of the meeting and the full Monetary Policy Report on Friday 15 May, which should allow the more hawkish part of the Bank Board to be partially identified (so for now we can only guess: Kubicek, Zamrazilová, Seidler).
In conclusion, I am adding a comment (from May 11) following the publication of the CNB forecast details.
It is often argued that higher interest rates are primarily the result of geopolitical risks and that, without the situation surrounding the Strait of Hormuz, CNB rates would be somewhat lower. However, the data from the Czech economy suggest a different picture.
The domestic inflationary story remains broadly unchanged. Rapid wage growth, combined with insufficient productivity growth, continues to keep unit labor cost growth elevated. At the same time, retail sales growth remains strong.
Markets are also shifting expectations for long-term rates higher. Implied 5-year rates, 5 years forward, have risen from levels around 3.5–4.0% in 2024 to a range of 4.0–4.5% since the second half of 2025.
This implies not only higher mortgage-related interest costs — which, given the strong growth in real estate prices, may even be desirable from the central bank’s perspective — but also higher costs of servicing government debt, both today and in the future.
The shift in CNB forecasts over the past year is also telling:
◽ core inflation for this year: from 2.2% to 2.8%
◽ nominal wage growth: from 4.9% to 6.4%
◽ unit labor cost growth: from 2.6% to 4.5%
And this is occurring despite tighter monetary policy than the CNB had expected a year ago (2.7% versus the current 2-week repo rate of 3.5%).
What follows from this? Lower interest rates may not automatically arrive with easing geopolitical tensions. The Czech economy instead points to the need for a discussion about tighter monetary policy than was expected at the beginning of this year. Any debate about lower policy rates should come only once structural changes capable of reducing domestic inflationary pressures are implemented.
The CNB's new forecast and its comparison with the original
Slower economic growth surprised the CNB
The CNB's new forecast and its comparison with the original
Compared to the previous forecast, the CNB expects slightly tighter monetary conditions at the annual outlook, offset by easier conditions next year
Inflation risks were also priced into market interest rates with longer maturities
EURCZK is close to the levels from the model with financial variables
