Komerční banka's makroeconomic forecast - the CNB is not expected to mind deflation caused by oil prices

Press release

Prague, 28 January 2015 – The Czech economy will continue in the 2014 trends this year. In 2015 again, the main driver of the Czech economy will be domestic demand, which continues to be stimulated by the relaxed monetary policy, the fiscal impetus and the positive shock on the supply side caused by the much lower oil and oil product prices. The plummeting oil prices will be the reason for the Czech economy fighting deflation for the first three quarters of this year. On the other hand, core inflation will safely nestle in the black, and we therefore do not expect any change in the monetary policy. Nothing is expected to change in the nature of the intervention regime, including the intervention level of CZK 27.00/EUR, this year.

Compared with the October issue, our forecast for the real economy’s development has not been changed in any significant way. In 2014 the Czech economy apparently grew at a rate of 2.3%, which implies the best result since 2008. We expect the same growth momentum this year again. Despite the concerns about the impacts of the CNB’s intervention, the new geopolitical factors (Russia-Ukraine) and the slackening economic growth in the euro area, in particular in the second half of 2014, last year we saw a rapid growth in consumers’ and businesses’ confidence to the pre-crisis levels, which helped domestic demand to recover.

Internal demand will be even stronger this year thanks to all three components, i.e. household consumption, government consumption and business investment activity. Household spending is supported by a rising rate of employment, rising nominal wages stimulated by the fiscal impetus in the form of an increase in civil servants’ salaries, which is also reflected in a stronger growth of wages in real terms thanks to low inflation, and by other fiscal measures. Investment activity is boosted by more positive expectations concerning future development, and by a growth in companies’ own funds resulting from a rising operating profitability. And in this segment, we should again highlight the fiscal policy and the government’s intention to increase its investment activity dramatically, mainly in respect of infrastructure.

Last year’s economic growth was based on broad fundamentals, with virtually all economic sectors contributing to this growth; this will also be the case this year. In the coming quarters, industrial production is expected to continue to rise from last year’s average growth of 4.9% yoy to this year’s 6.5% yoy. The construction industry is expected to develop similarly; last year, it experienced a growth for the first time following five years of decline. In this respect, this year’s major factor will be fiscal expansion supporting infrastructure projects, and we will probably also see more favourable development in the residential housing market helped by low interest rates and the expected increase in the prices of flats.

In the wake of the oil price fall, we have significantly revised our inflation outlook for this year. Following last year’s inflation of only 0.4%, for 2015 we therefore even expect slight deflation at -0.1%. The deflationary development is expected to hit its bottom of about -0.5% in February, and inflation is to turn positive again in the last quarter of this year. From central bankers’ perspective the crucial point is that core inflation is not expected to decline to the red while, in addition, the rate of inflation is expected to return to its target level next year and internal demand is expected to continue to gain strength this year. We therefore do not expect any change in the CNB’s intervention regime for the time being.

We have identified risks to this forecast in the external environment. Nevertheless, should these risks materialise, this should not have such as heavy impact as in the crisis years, since a drop in external demand would be cushioned by internal demand. However, growing deflationary risks imported from the euro area may pressure the central bank to weaken the Czech crown again.

Source: Economic & Strategic Research, Komerční banka.

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

Jan Vejmělek
Chief Economist, Komerční banka
Tel: +420 222 008 568