In the second half of 2011, the Czech economy experienced a mild recession. The main reasons were the fiscal austerity measures in most EU countries, which hampered external demand for Czech goods, and the spending cuts introduced by the Czech government, which had a negative impact on internal demand. The positive data from the beginning of 2012 indicate that the Czech economy has slipped out of the recession. However, we forecast a stabilisation rather than acceleration of growth for this year.

The April data on the Czech economy have brought a positive surprise. The economy may thus report a 0.1% qoq growth, which would mean the end of the shallow recession experienced in the second half of 2011. We expect stagnation for the next two quarters. Although the revision of full-year dynamics versus the end-of-March forecast of real GDP was minimal, it resulted in a 0.1pp improvement in our growth outlook for the economy, to +0.1% in 2012 and 1.3% next year.

Net exports will remain the key driver with a positive contribution to the economy’s overall growth of 2.6pp, as external trade marked a significant improvement in 4Q11 and at the beginning of 2012. We expect a record surplus of the trade balance of about CZK 280bn for FY 2012.

On the other hand, our outlook for domestic demand has remained negative due to the ongoing decrease in government spending and household consumption. The deterioration of the latter will continue as households’ purchasing power is affected by yet another round of fiscal austerity introduced at the beginning of 2012, higher inflation rate, weak growth in nominal wages, and rising unemployment. Consistent with this year’s minimal economic growth is an increase in the rate of unemployment from 8.6% in December 2011 to 9.1% at the end of 2012. However, unemployment will decrease from 8.9% in March to substantially below 8.5% in 2Q12 thanks to seasonal work.

The last months of 2011 and early 2012 saw a significant increase in consumer prices. The year-on-year dynamics climbed to 3.8% in March, which we believe will remain the 2012 watermark. Food prices have increased a cumulative 2.7% in the past six months (without the impact of the higher VAT rate and seasonally adjusted), and motor fuel prices increased 6.4%. We also saw increases in regulated items, and the lower VAT rate rose in January with a primary inflation impact of 1.1pp. On the other hand, prices of other items in the consumption basket decreased by a total of 0.2% (again without the VAT and seasonal impact; their weight in the basket is 60%), which confirms the absence of demand pressures on the inflation rate. Cost-related shocks and a weaker Czech currency at the end of last year were therefore the only reasons for consumer price hikes.

The most significant price jumps are over. Consumer inflation will slow down in the months to come to below 3% by the end of the year. On average, inflation rate is expected to reach 3.4% this year and only 2% in 2013. We estimate the actual impact of next year’s VAT change at 0.7pp (on the assumption of the VAT rate hike of 1pp).

We see no reason for the CNB’s Bank Board to increase the key rate at its following meetings. The current inflation is above the target only due to cost factors; core inflation and inflationary expectations remain low and the uncertainty in the external environment is high. Overall we expect the CNB to keep the rate at 0.75% until the end of 2013.

The most significant CZK weakening is over. The shallow recession we have seen since mid-2011 was accompanied by the weakening of the national currency, which culminated near the CZK 26.00/EUR level at the beginning of 1Q12. The current level below CZK 25.00/EUR is close to the equilibrium. In the short-term, we see a risks towards weaker CZK levels mainly due to the unresolved European debt crisis. In one year’s time, CZK should be stronger as we expect the economy to gradually move to the growth trajectory.

We see major risks of the macro prognosis abroad; the Czech economy does not suffer from significant macroeconomic imbalances. The banking sector is in a good shape, liquid and well-capitalised. The main risks include recession deeper and stronger in the eurozone than currently expected, a spill-over and escalation of the debt crisis (Portugal, Spain and Italy) and a potential inflationary shock connected to further increases in oil prices.

Macroeconomic forecast 2011 2012 2013
GDP (real growth, yoy in %) 1.7% 0.1% 1.3%
Household consumption (real growth, yoy in %) -0.5% -0.7% 1.4%
Fixed investment (real growth, yoy in %) -1.2% 0.5% 0.0%
External trade balance (CZK bn) 191.3 279.7 293.7
Industrial output (real growth, yoy in %) 7.1% 1.7% 1.6%
Retail sales (real growth, yoy in %) 2.0% 0.3% 1.1%
Wages (nominal growth, yoy in %) 2.2% 2.3% 3.5%
Unemployment (MPSV*, in %) 8.5% 8.6% 9.2%
Inflation (yoy in %) 1.9% 3.4% 2.0%
Adjusted inflation (yoy in %) -0.2% 0.0% 0.2%
Food prices (yoy in %) 4.6% 2.5% 2.8%
Fuel prices (yoy in %) 9.8% 6.5% -5.2%
Regulated items and taxes (yoy in %) 4.8% 7.1% 3.8%
3M PRIBOR (average) 1.19% 1.24% 1.22%
2W Repo (average) 0.75% 0.75% 0.75%
EUR/CZK (průměr) 24.6 24.8 24.1

Source: KB

* MPSV: Ministry of Labour and Social Affairs