Interest rates are only falling by half a percentage point. The central bank is cautious. There are certainly risks ahead

Prague, May 2, 2024 (PROTEXT) – At today’s meeting, the Banking Council of the CNB decided to reduce interest rates by half a percentage point. The two-week repo rate thus fell from 5.75 to 5.25%. This is completely in line with market expectations.

At the last session, the central bank had room for a very significant reduction in interest rates, as inflation fell below the central bank’s forecast, up to the central bank’s target. If the Bank’s Board did not respond to this, it was clear that it was committed to the traditional policy of small steps, which usually do less to spoil than big steps. Therefore, no one was surprised by today’s decision and it is not necessary for the market to react in the form of a reduction in bond yields. This was already reflected in the market a long time ago.

The question is what happens next

At first glance, there is a risk that we will move from inflation to deflation. But during the last six weeks, a lot has been added. I see the development of inflation in the USA as a big problem. Inflation doesn’t seem to be on the decline there. Therefore, the central bank has kept interest rates unchanged for a long time and will probably continue to do so.

We are seeing the market gradually shift the expected rate cut from a cut in the summer to a cut at the end of the year, and today there is a lot of talk about a rate cut only in the first quarter of 2025. This takes the wind out of the sails of all those who were betting on global monetary policy easing.

We see that even the ECB is not going anywhere. He waits. That is why prudent economists recommend that we should wait and see what happens in the economy before lowering rates. They point to an increase in the price of services and a potential weakening of the koruna. But the announced weakening is not coming. On the contrary, the koruna has been strengthening against the euro since mid-April. The exchange rate is gradually returning to where it was in February. So no tragedy occurred. I understand that argument. But as long as we are above the level of ECB rates, I am not too afraid of the weakening of the koruna.

For the central bank, it is crucial that inflation is within the CNB’s target. The question is whether it will stay there. If they do not significantly reduce rates, the koruna may not weaken and bring inflationary pressures. Let’s welcome the impact of rising service prices and not fight it. This increases our wages so that they can converge to Western Europe. Despite the turmoil in the Middle East, oil is moving calmly. Inflationary pressures are therefore under control for now.

I see global development as a risk. We feel that we are more and more connected. Rising prices in the US could also spread further across the planet. In Europe, however, the situation is calm. In the eurozone, consumer prices are growing by only 2.4% year-on-year. There is nothing to worry about yet, so I would continue to cut interest rates by half a percentage point one more time. Then it can be quite risky. This will be a new forecast and a difficult decision.

The fact that the CNB is resisting a further reduction in interest rates is of course holding back the economy. This year it will grow only in the order of tenths of a percent. It will be another wasted year from 2019. With high interest rates, the economy will not move. I wouldn’t be at all surprised if we don’t go back to pre-covid levels. That’s crazy. Everyone has recovered, but we haven’t.

Vladimír Pikora, Chief Economist of the Comfort Finance Group

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