Is Czech Central Bank the Most Hawkish Bank Right Now?

On its latest monetary policy meeting, Board of Czech central bank decided to leave rates unchanged as widely expected. However, their statements says that interest rates should be stable initially, “.. followed by a gradual rise in rates from roughly the middle of this year onwards. “ This means that in case Czech economy accelerates pace of recovery, CNB could be the first central bank in EU to start tightening its policy already this year. In this article we are looking at the drivers for such a decision by CNB and monetary policies across the globe.

As you may already know, CNB was regarded as one of the most hawkish banks in the world even before the corona crisis. It managed to hike its rates several times in period of 2018-2020 to 2.25% (2-week repo rate) as economy was roaring. Back then, inflation kept rising and stood above CNB’s target of 2.0% while Czech koruna witnessed strong appreciation trend due to EM inflows but also due to solid carry trade. It is worth noting that CNB lifted its interest rates once in February 2020 as inflation reached multi-year high of 3.7%. Nevertheless, corona crisis kicked in in March and central bank had to reverse some of its decisions. That did not seem to be the problem for CNB’s governor Jiri Rusnok and his officials. Namely, CNB cut its interest rates down first on March 17th by 50bps, then by 75bps 10 days later and then finally by another 75bps in May, to reach 0.25%. As it was the case with the rest of the EM, CZK depreciated strongly and almost reached 28.0 versus euro while inflation rates dropped significantly.

Since the second quarter of 2020 which was one of the worst quarters in respect of economic collapses, a lot of things have changed. Vaccines process is accelerating while businesses and consumers became adapted on „new normal„ meaning that after Q2 economies started to recover. Last year Czech economy decreased by 5.6%, reflecting the biggest decrease of GDP on the record, although looking at the Q2 when economy was lower by 10.7% YoY, it could have been worse. Meanwhile, restrictions in Czech Republic and the rest of Europe are still in place and could be lifted only gradually which concerns retail and service sector. On the other hand, export and industry-oriented services fared quite well in the last few months and were hit only to a small extent. Considering above said, CNB expects economy to grow by more than 2.0% this year and to fasten next year, reflecting return to the pre-corona levels.

Talking about pre-corona levels, CNB does not expect inflation to reach levels from the beginning of 2020 but only to fall further close to 2.0% and to fluctuate around the target in the following period. Recovery of the economy and stable inflation around the target leads us to the latest monetary policy meeting by CNB a week ago. Although Mr Jiri Rusnok stated that CNB could hike one, two, three or maybe zero times in 2021 even before the meeting, some analysts interpreted his statement as slightly hawkish as he mentioned even three hikes this year. In the statement CNB says that they could start hiking rates in H2 and on the presentation it could be seen that they expect rates to reach 1.0% in the end of 2021. One should bear in mind that all the central banks in the region are still talking about loosening monetary policies rather than tightening while ECB seems to be miles away from even mentioning tightening. Although we think CNB’s projections are a bit too optimistic, we expect economies to recover above consensus and that vaccine rollout will accelerate further in the following months. That scenario could support CNB’s expectations and Czech central bank could be the first European central bank that started to tighten its policy. CNB’s projections have driven CZK appreciation in the last few weeks and it reached 25.70 versus EUR, being only 3.0% above pre-corona levels. In case, optimistic scenario becomes reality and CNB manages to hike several times this year, we do not exclude EURCZK trading at 25.0 at the end of this year.