Will the CNB stay at 3.5% or just pause and for how long?
Economic commentary by Jaromir Šindel, Chief Economist of the CBA
The CNB Bank Board left the two-week repo rate unchanged at 3.5%. The decision was expected, just as I was not surprised by its unanimous adoption. For me personally, the May cut to 3.5% was already something of a surprise - I had expected less than six out of seven votes at the time. This was mainly due to stronger core inflation growth. While the Governor is watching six-month momentum, I prefer three-month momentum, which can provide earlier signals - unless it is significantly distorted by fluctuations in imputed rents (see chart below). Adding to the inflationary drag is the solid performance of the economy. This combination has been confirmed by new data, including better economic performance in April and rather inflationary GDP and wage details for the first quarter.
From the CNB's perspective, there has been an increase in upside risks to inflation, mainly due to the inertia of rising services, real estate and food prices. For the latter, money supply growth remains faster - both due to the recovery in the mortgage market and with the risk of a contribution from fiscal policy, where I indirectly perceive a risk of a post-election change in fiscal strategy. Another factor remains the risk of continued, inflationary wage growth.
From the sound of Governor Michel's presentation, I get the impression that the interest rate will remain at 3.5% for longer - probably beyond the summer months. This still leaves open the possibility (albeit a ajar door, not a door) that the rate will fall to our forecast 3.25% by year-end. However, the market does not expect this development until the second quarter of 2026. The labour market situation, wage developments and mortgage demand will play a key role. May's transaction and mortgage data signal to me stability rather than a growing boom.
The CNB's June meeting on financial stability and macroprudential policy (more on this in the commentary here and the last chart) leaves the inflation risks associated with the housing market on the shoulders of the CNB's monetary, i.e. interest rate, policy. This increases the likelihood of a longer pause in rate cuts - i.e. a longer stay of the repo rate at 3.5% after the August meeting.
However, this development may not fully and permanently translate into longer yields on the curve if tighter monetary policy effectively mutes the inflationary charge in the economy. For this to happen, it will be necessary to continue and intensify the government's structural reforms to weaken inflationary pressures from the labour market. The CNB has limited options in this area.
Summary of economic and inflationary developments that influenced the CNB's stance:
- WhileJune sentiment may signal a slight relief for service prices in core inflation, it nevertheless sends positive signals for economic growth and the labour market in the near term. Together with the April data, it thus represents an upside risk to our GDP growth forecast of 1.7% y/y. The first quarter GDP result alone moves it closer to 2%.
- If strong price momentum in core inflation - with its current annualized 3-month growth of over 3.3%) - persists and the economy continues to outperform expectations, then this pause in rate cuts will last longer than one monetary policy meeting. Conversely, if the signal from lower price expectations in services materializes, then this could indeed be a temporary pause in rate cuts - not the end of them. However, this would also require a moderation in wage growth relative to productivity developments, which the data so far do not suggest.
Charts: momentum in core inflation, interest rate settings in the region and the impact on EURCZK, market expectations and an overview of the CNB's regulatory requirements.
Momentum of core inflation: comparison of 6-month vs. 3-month momentum and its decomposition on a 3-month sample
Central bank interest rate settings in the region and the world: the CNB at 3.5% (dark blue) is above the ECB range of 2-2.15%, but well below the region Poland at 5.25%, Hungary and Romania at 6.5% vs. the US Fed at 4.25-4.5%
Tighter CNB monetary policy is reflected in a stronger koruna
Market expectations: the market is pricing in a further interest rate cut only in the first half of 2026. The stability of rates is also reflected in the 3M PRIBOR, which remains close to the CNB's 2-week repo rate.
The Czech banking sector: a look at capital, assets and CNB requirements
Source: CNB, CBA
Note: Unless otherwise stated, we work with seasonally adjusted figures in the text. Annualized developments show possible year-on-year growth if current month-on-month dynamics are maintained.