Stagnation and Struggles: Assessing the Czech Economy's Road to Recovery
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In 1Q23, we believe the Czech economy may have ended a soft recession, given the previous QoQ decline of 2H22 turned into stagnation but remained still negative in YoY terms (-0.4%). We expect the annual growth of GDP to remain negative in the first half of 2023.
This reflects a continued decline in household consumption, which fell deeply by 6.4% YoY, following a sharp decline in the inflation-driven fall of purchasing power of households, while corporates cut their investment on the back of weak foreign demand and high costs of lending. On a positive note, inflation is on a declining trend owing to an ongoing decline in core inflation, given a slowdown of food and fuel prices. This is likely to prevent the CNB from increasing interest rates despite the still tight labour market and the risk of a potential wage-inflation spiral.
Forecast summary
Macro digest
After two consecutive declines in GDP growth during the second half of 2022, the Czech economy in 1Q23 stagnated but remained negative in YoY terms (-0.4%). The main obstacle in economic recovery remained private consumption, which declined in the first quarter of 2023 by 6.4% YoY, as double-digit inflation squeezed markedly the purchasing power of households, while high interest rates and soft foreign demand led companies to reduce the growth of investment.
We expect the annual growth of GDP to remain negative in the first half of 2023 due to still declining household consumption. During the remainder of 2023, however, the economy is likely to show signs of a recovery, as gradually receding inflation will weigh less on the real purchasing power of households and the ongoing improvement of the external environment should support a recovery of exports. Yet, investment demand is likely to remain weak due to persistently high interest rates.
Real GDP growth structure (ppt of YoY growth, SA adj)
The unemployment rate (ILO) fell 3.6% to 3.5% in May. However, it stagnated at 3.6% on a seasonally adjusted basis. Nevertheless, the overall labour market in the Czech Republic remains extremely tight, even though firms in the PMI survey reported further layoffs in May due to fewer new orders.
However, recent developments in the Czech industry and retail sector are not very favourable, which could be reflected in the pressure to lay off employees.
For the time being, however, companies are still trying to hold on to employees in the hope of a recovery in demand.
The overheated labour market is thus also reflected in rapid wage growth, particularly in industry and construction. The first quarter showed nominal growth of 8.6% YoY, but in real terms growth is deep in negative territory and a turnaround can only be expected in the third quarter.
Czech PMI underperforming region
Inflation, in our view, posted its last double-digit reading in May and will continue its swift disinflation for the rest of the year. The slowdown or even decline in inflation can be seen across the consumer basket. However, the main drivers are and will be food, fuel and housing prices.
Food and housing prices in particular, in our view, still have the potential to collapse faster than expected and headline inflation will surprise more to the downside. At the moment, year-end inflation should be around 8% YoY and, thanks to a large base effect and the re-pricing of energy prices, we should be in the 3-4% range as early as January next year.
Structure of inflation (ppt)
Government promises fiscal package to tame deficit
May's state budget deficit of CZK270bn, the worst result in history, confirmed the trend of weak tax revenues. For this year, the government is projecting a deficit of CZK295bn, however, given current developments, it plans to introduce measures to tame the growing deficit. Thus, for this year, we expect a general government deficit of 3.8% of GDP.
Looking ahead, for the next two years, the government has unveiled a large consolidation package that will soon enter the legislative process. The government is targeting a deficit of 1.8% for next year and 1.2% of GDP for 2025, which would be by far the lowest number in the region. We expect slightly higher numbers (2.3% and 1.8%), but in any case, consolidation will be ongoing, which makes a difference.
General government balance (% of GDP)
