Prague, 1 August 2017 – The Czech economy is growing this year, and registering one of its most successful periods. Compared with the past years the Czech Republic no longer lags behind its regional neighbours in terms of growth. Czech households are also benefiting from the economic growth. The employment rate has hit a new record: this year, wages will increase at the fastest pace since 2007. The growth in investments and productivity is a promise that the wage dynamics will continue in the coming years. Despite the stronger Czech koruna and weaker inflationary tendencies abroad, the domestic wage pressures should ensure that price hikes will exceed the inflation target. The CNB will therefore continue in its return to the standard functioning of the monetary policy. The coming Thursday is expected to see the first rate hike since 2007.

According to Komerční banka’s updated forecast the Czech economy is expected to grow by 3.7% this year.Disregarding 2015, when the Czech economy improved by 5.4% due to the need to invest EU funds from the preceding programming period, this year the Czech economy will grow at the fastest pace since 2007. “We see growth everywhere around us,” claims Jan Vejmělek, Komerční banka’s Chief Economist. “As regards the growth outlook for this year, our forecast is the most optimistic on the market,” he adds.

The European economy’s improving conditions is helpful for the Czech economy.The German economy is going through one of the most successful economic periods since the country’s reunification. “Some other large countries that definitely did not make us happy in the past, such as France, Spain and Italy, are getting into a surprisingly decent condition,” addsJana Steckerová, Komerční banka’s economist.

The lowest ever unemployment and the large number of vacancies clearly bear out that the labour market has hit its limits. According to Viktor Zeisel, Komerční banka’s economist, it is obvious that “a growth model relying on using steadily rising numbers of cheap labour has been exhausted. The private sector is gradually becoming aware of the need to invest and to base its business model on innovations and higher productivity.” From this perspective, we are delighted to see the private sector’s higher investment activity that has been apparent since the beginning of this year. However, we are still waiting for the public sector getting going and increasing investing. The need to draw on the EU funds will be the impetus triggering its high investment activity in 2018.

The shortage of new labour force and the growth of productivity will naturally pressure for wage increases.Nominal wages will rise by 6.4% on average this year; the last time wages grew faster was in 2008. And, importantly, “wages will also briskly grow in the coming years,” adds Viktor Zeisel. In addition, growing wages will be the main factor that will push inflation upwards. However, this will be countered by the import of lower inflationary pressures from abroad also thanks to the Czech koruna appreciating against the euro and the dollar. We estimate this year’s average inflation at 2.3%, and at 2.2% for 2018.

Throughout this year, inflation is staying above the 2% target and the wage pressures will also ensure its sustainability over the medium term.In our opinion, the strengthening of the Czech koruna to date has been in line with the central bankers’ expectations. According to Viktor Zeisel, the conditions are now in place for the CNB Board members who want to break away from the zero level of interest rates to raise their hands in favour of this decision. “The majority will be found as early this coming Thursday at the Board meeting,” Viktor Zeisel predicts. We expect another rate hike towards the end of this year; next year, the CNB is expected to take this step as many as three times. According to Jan Vejmělek, “the more attractive interest differential will be another of the factors that will underpin the current trend of an appreciating Czech koruna”. He adds that the exchange rate may climb to CZK 25.50/EUR still in 2017.

Marek Dřímal, Komerční banka’s strategist, expects that the central bank’s higher rates will also be reflected in the market rates. “And so, loans are expected to become more expensive, including mortgage loans,” Marek Dřímal believes. The yields from the Czech government bonds should also grow slightly. In 4Q 2017, the government will have to increase its sale of debt to cover the repayment of old bonds.

For 2018 we expect the national budget deficit to amount to CZK 50 billion, i.e. the same as the tentative proposal of the Ministry of Finance and the cabinet. The rapid growth of the economy should support revenue, while expenditure will go up due to the massive salary increases in the public sector and increased welfare benefits. “Investments should perhaps also be higher at last due to the need to draw down a part of the allocation of the EU funds by the end of 2018; otherwise, the country will lose this money,” Marek Dřímal adds.

Source: The Czech Statistical Office; the Czech National Bank; Ministry of Labour and Social Affairs; Macrobond; Economic and strategic research, Komerční banka;

Note: (*) external trade as per cross-border statistics; (**) inflation components net of primary impact of tax changes