Consumer price inflation slowed to 2.1% year on year in May, close to the CNB's target. However, domestic inflationary pressures continue to operate beneath the surface. Core inflation remained at 2.9% y/y and its short-term dynamics suggest an acceleration closer to 4%. The latest economic numbers do not suggest a reversal and thus a relief of the inflationary nature of the Czech economy due to strong wage growth and weak productivity growth. This constellation, together with the ongoing Iranian conflict, reinforces the rationale for a 0.25 percentage point increase in the central bank's interest rate to 3.75% at the June meeting. This will not be an easy decision for the Board.

April's monthly figures open the way for stronger GDP growth in Q2 for now, after slowing to 0.2% q-o-q in Q1. The April industrial numbers are 1.8% above the first quarter average thanks to the April rebound. Despite a slight April decline, the construction sector is on an uptrend, thanks in part to strong housing starts, which rebounded from weaker building permits. Moreover, its sentiment does not suggest a change in trend. Foreign trade reached its lowest surplus below CZK4bn since the end of the energy crisis in 2022. However, this mainly reflects higher non-energy imports, while export activity also showed solid growth thanks to ICT. Thus, net exports are unlikely to drive GDP, similar to the first quarter when their weaker contribution was offset by stronger investment activity.

April's decline in retail sales was largely the result of a correction of the previous strong growth in fuel and food. Although the correction after a strong March was also evident in core retail sales, they maintained their growth momentum, confirming the continued willingness of households to spend, supported by real wage growth and credit activity. However, factors are beginning to emerge in the second quarter that may slow the pace of household consumption. We discuss three of them below - real wage growth, credit activity and retail bonds.

Consumer price inflation slowed to 2.1% in May, surprising at a more moderate pace than the market had expected. However, some of the factors now dampening inflation may not be permanent. This is particularly true for food prices, which may be affected by rising global commodity prices in the months ahead. At the same time, strong wage growth of 8.1% year-on-year is divorced from labour productivity, creating pressures for higher core inflation. It is the contradiction between low headline inflation and persistent domestic inflationary pressures that poses a non-trivial economic and political dilemma for the CNB.

The Czech economy grew by 0.2% quarter-on-quarter in Q1. The weaker result was mainly due to technical factors, including the negative contribution of net exports and the budget provisionality. However, the structure of growth remains favourable thanks to continued growth in household consumption, investment and exports. In addition to the Iran war, weaker industry and persistent wage inflation pressures with slower productivity growth pose risks to the recovery to 2% economic growth this year.

Slightly worse sentiment in May hides a drop in expected large purchases by consumers. If they translate into worse retail sales results in the coming months, these more modest plans would pose a downside risk to the 2% growth outlook for the Czech economy this year. This is based on a stable growth of almost 3% in household consumption. Other details reveal a slight correction in price expectations, which mitigates upside risks to inflation. The labour market receives a neutral report given its recent trend, i.e. slightly negative.

This year is bringing a strong wave of expiring mortgage rate fixations, while the shorter fixation periods agreed in recent years will further increase these volumes in the years ahead. Building on the central bank’s latest estimate that mortgage fixations worth an average of CZK 534 billion per year will expire between 2026 and 2028, we present alternative interest-rate shock scenarios depending on the path of mortgage rates. In 2027–2028, the negative interest-rate shock is expected to ease to 0.1–0.6 percentage points, down from 1.1–1.4 percentage points this year. However, we also outline a more adverse scenario involving a stronger interest-rate shock. This year, the negative interest-rate shock affecting expiring mortgage fixations from the low-rate period will amount to roughly 3.5% of the average household income of mortgage applicants, although across all households the average impact will be about half that level. In both cases, the expected real growth in wages and salaries should be sufficient to offset the shock.

March retail sales returned to strong growth, while March did not bring a turnaround in the stagnation of services. Industrial production did not build on February's better numbers, and a more significant deterioration was prevented by energy-intensive sectors, which does not look like a robust support in the current energy shock. Export activity also remained weaker. However, the month-on-month decline in imports resulted in the return of a solid foreign trade surplus of CZK 18 billion. Construction output, on the other hand, continued to outperform, especially in the buildings segment. However, despite still weak building permit numbers, the number of construction starts continued to rise. Infrastructure construction, on the other hand, remains weaker, presenting an opportunity for future growth. The output side of the economy thus developed in March in line with the weaker GDP growth of 0.2% q-o-q in the first quarter, which was characterised by a decline in industrial activity and a deterioration in foreign trade. These factors were only partly offset by stronger construction output and solid growth in trade and services sales (still with February data). For the CNB, the data, along with higher unemployment and softer industrial wage growth, signal a less hawkish environment than the still elevated momentum in core inflation suggests.

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.

April consumer prices accelerated to 2.5% year-on-year and the story behind the inflation numbers is very similar to March. The acceleration mainly reflects higher fuel prices, but higher core demand inflation and, more recently, higher alcohol and tobacco prices are also creeping in. While energy and food prices still dampened the acceleration. The current dynamics and the Iranian conflict pose a risk of higher inflation for this year, and for the outlook for next year. While risks to the forecast remain volatile due to the uncertainty associated with the Iranian conflict, even if it calms down, higher core inflation represents a hawkish signal for the CNB in the form of a higher interest rate.

GDP growth slowed to below 0.2 percent in the first quarter, a negative surprise. Instead of the expected household consumption, the economy was mainly driven by investment, while foreign trade worked against growth. However, the weaker consumption may be only a temporary correction after the strong end of last year. The same applies to industrial production, and the government's temporary budget provision also had a negative impact on the first quarter. The outlook will be significantly affected by the intensification of the commodity supply crisis due to the Iranian conflict.

At its meeting on 7 May, the Czech National Bank is likely to leave its interest rate unchanged at 3.5% and the tone of its communication is likely to be hawkish. This will neither surprise nor offend, but neither will it please. In the meantime, long-term market rates are rising, pricing in not only an unresolved Iranian conflict but also upside risks that may allow the effects of an energy shock to seep through. This is reflected in a further rise in the long-term equilibrium interest rate, which is at levels seen in 2023 when the central bank rate was double, which is bad news for long-term investments. Data at the end of May and beginning of June will show the state of the inflationary underpinning in the Czech economy. This will be crucial not only for the market interest rate reaction but also for the monetary policy stance if the Hormuz closure continues. In the meantime, economic policy should respond with structural changes to ease long-term interest rates.

April sentiment already reflects the impact of the Iranian conflict on the Czech economy more strongly, but unevenly across sectors. Sentiment deteriorated as expected in industry, households and retail trade, while services dampened the overall deterioration thanks to stronger demand and construction. Price expectations continued to rise in industry, households and construction, while retail sales remained close to the long-term average and services corrected slightly after the previous increase. Meanwhile, labour market effects remain limited even in the harder-hit sectors and, in fact, the overall slightly worse sentiment still does not provide an immediate signal for worse growth expectations for the economy.

According to Eurostat data for March, the price of diesel at Czech petrol stations rose the most in the EU, by almost 28% month-on-month, while the average increase in the EU was 19%. I am not an expert on the pricing policy of petrol stations, the density of petrol stations or the pricing policy of refineries. However, if I look at the EU fuel price statistics, it is clear that the March jump reflects: 1) the low starting price in the Czech Republic - the third lowest in the EU; 2) the lower taxation of diesel in the Czech Republic - the fourth lowest in the EU; 3) the different pricing and tax policies across EU countries in March.

Comment by Jaromír Šindel, Chief Economist of the CBA: Mortgage rates are significantly determined by the movement of market interest rates. However, structural factors in the banking market are also important. The CNB's investigation of credit conditions in our analysis helps to explain what factors influence the difference between mortgage and market interest rates deviating from its normal level. The CBA analysis shows that a combination of stronger demand and competition among banks plays a key role. It is the latter that can lead to more favourable rates for clients without undermining market stability. The difference between mortgage rates and market rates that we have been monitoring is therefore mainly dampened by stronger demand, but in an environment of growing competition, which is key. Banks' profitability also plays a role, acting as a corrective mechanism to maintain competitive interest rate spreads but also market stability.

The March acceleration in consumer price inflation to 1.9% was not surprising in itself, but the acceleration in core inflation to 2.9% was less favourable, including the momentum across key segments. This indicates that price pressures in the domestic economy remain strong, especially for labour-intensive services and imputed rents, but also the koruna no longer provides a disinflationary factor for goods prices, amid strong household demand. For the Czech National Bank, the March core inflation is a hawkish signal that may reinforce interest rate growth expectations, especially if the current energy shock persists.

March inflation accelerated to 1.9% year-on-year in March, mainly reflecting higher fuel prices. However, the acceleration was somewhat milder than expected, helped by lower food prices. However, preliminary data suggest an acceleration in core inflation to 2.8%, which is not surprising given the still strong growth in retail sales. Although these did slightly correct the previous strong increase in January in the core segment in February. However, the strength of demand is relatively limited given the rather sluggish sales in services in the first two months of the year. The central bank will monitor the dynamics of these demand pressures, wages and core inflation, which will determine the speed and extent of its interest rate hikes in the coming months. Stronger demand is also translating into more robust imports, shrinking the foreign trade surplus that has not yet been affected by the energy price shock.

The koruna weakened slightly in Q1, especially in March, under the influence of geopolitical tensions and higher risk aversion in the markets. However, higher interest rates prevented a more pronounced depreciation. The Czech currency thus remains stronger than at the beginning of last year, which is also cushioning the effects of the current energy price shock.

According to the CSO statistics, property prices, which include land and family houses, rose by 2% quarter-on-quarter in the final quarter of 2025. This slowed from the previous average 2.6% increase in the previous four quarters. Although the income side of demand is still lagging, real household incomes accelerated more sharply at 1.4% q-o-q (up nearly 3% in nominal terms) at the end of last year. And so did the household savings rate, which rose to 19.7%. Moreover, both figures were positively revised and there was a slight positive revision to GDP growth in the final quarter of 2025, albeit with more limited effects on the economic outlook.

The Czech economy accelerated at the end of last year and maintained its inflationary bias due to strong household consumption and strong wage growth unsupported by productivity. However, the central bank's New Year communication hinted at a possible interest rate cut. However, this rhetoric has been changed by the recent energy shock. For the central bank, the dynamics of core inflation will be key in the coming months, but also the pass-through of higher oil and gas prices to other price segments in the economy. March price expectations rose, but their April perception will be more guiding for the central bank.

Wage growth remained strong at the end of 2025. Average wages rose by 7.4% year-on-year and added 7.2% for the year as a whole. Thanks to low inflation, this meant real wage growth of 4.7%, higher than forecast. While nominal growth should slow this year, real wages may continue to grow solidly. The average nominal wage reached CZK 49.2 thousand last year, surpassing CZK 50 thousand at the end of the year on a seasonally adjusted basis and reaching almost CZK 51 thousand in market sectors. The median wage of CZK 42 thousand was approximately 85% of the average wage.