Central Bank Focuses on Extending Rate Stability Amidst Inflation Concerns

Board pushes for longer rate stability

Given that the upside risks to inflation mentioned by the CNB should be under control, the main theme for the summer months will be for the central bank to fight the market's dovish expectations. For June, we expect inflation to fall to 9.5% YoY and move below 9.0% later on. Disinflation is set to slow significantly in the autumn months due to the base effect and we may even see a slight pick-up towards the end of the year - reflecting the base effect and government measures introduced late last year.

 

This trajectory is the central bank's main concern at the moment, in our view. In our base case, we expect the first cut to take place in November, when the CNB will have a new forecast including a Nowcast for inflation for the rest of the year. By that time the impact of the base effect and energy repricing in January will be clearer, and inflation could reach the tolerance band of the CNB's inflation target. The risks we see are that rates will remain unchanged for the rest of the year and that the cutting cycle will not start until February, when the CNB will release its next forecast, or in March, when the board will already have January inflation to hand.

 

What to expect in FX and rates markets

The Czech koruna has been trading at weaker than expected levels in recent weeks, but we still believe EUR/CZK should go lower. On a global level, the CZK should benefit most from a rebound in EUR/USD, while the CNB will try to postpone dovish market pricing, which should support interest rate differentials. On top of that, market positioning is rather light compared to PLN and HUF and carry is still decent. We expect the koruna to move below 23.70 EUR/CZK in coming days.

 

Market expectations did not change much after the CNB press conference, despite higher volatility. The market at the moment expects a first rate cut of 25bp in September and more than 100bp by the end of the year. Our expectations and the risks together mean that we believe the market is too dovish. It will be hard for CNB to change market expectations in the coming weeks and we cannot expect a complete pricing out of rate cuts this year. Moreover, over the longer 3-4y horizon, the market is pricing in a near return to 3%, the CNB's equilibrium rate. From this perspective, we do not think the short end of the curve has much room to price in more rate cuts and see more of a case for higher rates in the market.