In an environment of falling inflation, the following year will be marked by a reduction in interest rates by the CNB. This will lead to a decrease in bond yields, and therefore an increase in their prices. That is why bonds are already a very interesting investment opportunity. However, the following factors need to be taken into account: the selection of suitable bonds in terms of their time to maturity, the right moment to buy bonds and the estimation of the moment of their future sale.
The main factor affecting the Czech economy in 2023 was and continues to be the high rate of inflation, despite the fact that it has significantly decreased since January of this year. Let us recall that the inflation rate in January was 17.5% and since then we have been recording lower and lower values every month. In June of this year, the inflation rate fell below 10% for the first time since January 2022, and in September it was even at the level of 6.9%. Only in this situation can the Banking Board of the CNB consider a possible reduction in interest rates. The main interest rate in the economy, the so-called repo rate, is at the level of 7% from June 2022. However, the Bank Board left the repo rate unchanged at its meeting on November 2, 2023. Part of the market was surprised by this, however, in my opinion, this decision was the right one given the persistent risks of increased inflation in the future. Here I would mainly mention the expected increase in energy prices next year and some of the effects of the consolidation package prepared by the government. In addition, October’s inflation will most likely be nominally higher than September’s, given the low comparative base from last year. There was a cost-saving tariff that reduced energy prices in the last three months of last year.
There is, however, another danger in the case of a rapid reduction of interest rates by the CNB. Every reduction in interest rates has a direct effect on the weakening of the Czech crown against the major world currencies. In its fight against inflation, the CNB did not raise interest rates, but bet on a strong koruna, which was announced by Governor Aleš Michl in December last year. This is no longer the case. In the summer, the CNB formally ended the intervention regime after not actively intervening in favor of the crown for almost a year anyway. This decision has a deep logic in that it was necessary to at least verbally loosen the koruna before the CNB starts reducing interest rates. Since this decision, the koruna has weakened from its maximum of around 23.30 CZK/EUR to the level of 24.70 CZK/EUR. After the Bank Board decided by a vote ratio of 5:2 on November 2, 2023 to keep the repo rate at 7%, the koruna strengthened sharply to 24.40 CZK/EUR, given that the market had already built the expected reduction into the koruna exchange rate. In view of this, the question is whether the CNB will continue to reduce interest rates this year, e.g. at the last monetary meeting on December 21, 2023. This is because every such reduction reduces the interest rate differential between the koruna on the one hand and the euro and dollar on the other. This differential has significantly decreased in recent months, already because both the ECB and the FED have significantly increased interest rates.
Any reduction in interest rates will also have an impact on bond yields, which will also decrease. At the end of October, the yield on the benchmark 10-year government bond was almost 5%, and at the beginning of November it fell to around 4.5%. In general, a decrease in interest rates in the economy, and thus a decrease in bond yields, leads to an increase in their price. This is especially true for bonds with a long maturity. Thus, after several years, bonds are once again in the center of attention of investors. Given the future decline in their revenues, it will be a very interesting investment opportunity, especially in 2024. However, the following factors need to be taken into account: the selection of suitable bonds in terms of their time to maturity, the right moment to buy bonds and the estimation of the moment of their future sale. Mainly, the selection of bonds from the point of view of their time to maturity is important in that, in the event of a drop in yields, there will probably be a different drop for different maturities, i.e. a certain distortion of the yield curve. This applies not only in the Czech Republic, but also in the USA and Europe. This global future decline in interest rates and bond yields also leaves room for equity prices to rise. Therefore, the year 2024 may be marked by a bull market, when stock indexes, as well as individual stock titles, will grow.
Overall, however, the financial markets will be affected by the geopolitical situation, which has worsened significantly in recent times, whether it concerns the ongoing war in Ukraine or the current Israeli-Palestinian conflict. In the medium term, this can have a significant impact on the growth of the price of oil and energy in general. Then the weak koruna, which favors exports, could become a big disadvantage for our open economy.
doc. RNDr. Petr Budinský, CSc., vice-rector for strategy and international relations, member of the board of directors, University of Finance and Administration, as
Article taken with the permission of OVB Allfinanz, asz www.ovbjournal.cz
Author: Petr Budinsky