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The Banking Council of the Czech National Bank (ČNB) will meet on Thursday to decide on the setting of interest rates for the last time this year. The seven councilors are awaiting a crucial debate and probably a very close vote as well. The first interest rate cut in a year and a half is at stake, which can affect the market, including mortgages.
In addition to the worse condition of the domestic economy, this step is also supported by inflation, which is gradually moving towards the desired two percent goal of the central bank, although its year-on-year value was 7.3 percent in November. However, the effect of the lower comparative base, which was caused by the temporary energy saving tariff introduced by the government last year, was reflected in this number. Without it, inflation would be around five percent, according to estimates.
Inflation could take a more significant step closer to the central bank’s target at the beginning of 2024. At least that is how it is outlined in the current CNB forecast, and some economists see it the same way. The mix of falling inflation together with the slowdown of the domestic economy is fueling the arguments for at least a small reduction in rates by a quarter of a percentage point already this Thursday.
The main rate, the so-called repo rate, from which the prices of loans for businesses and households are based, could thus fall below the seven percent limit, to which the then “Rusnok” council moved it last summer, before the current governor Aleš Michl took the helm, under which was dominated by interest rate stability.
However, there is also a second scenario on the table, which for a change is supported by a possible more significant increase in the price of goods and services in January. It is this unknown part of the equation, i.e. how entrepreneurs and companies will adjust their price lists, that may cause uncertainty on the part of the bank board, as a result of which they will postpone the easing of monetary policy until next year.
“Uncertainty about the January revaluation has not decreased significantly. So for me, the December session is 50/50 at the moment,” CNB Vice-Governor Eva Zamrazilová said in a recent interview with Bloomberg.
However, according to councilor Jan Procházka, postponing the rate cut to February may create the impression that the CNB does not believe that its forecast of three percent annual inflation in January will come true. However, Procházka is convinced that inflation will reach the triple, as he told Reuters.
He also mentioned that with the completion of the cycle of rate hikes by major central banks, the markets’ attention turned to the timing of the first cuts. “Thus, for me, one of the significant risks preventing the reduction of rates in our country has receded,” he added.
Both Zamrazilová and Procházka were part of the five-member majority in the Bank Council that voted for the stability of rates at the last monetary meeting in November. If they change their mind on Thursday, that should be enough to ease monetary policy.
As for the next steps of the CNB, Vice Governor Jan Frait, who voted for the rate cut already in November together with Tomáš Holub, is clear. “I consider it possible, or even desirable, to approach the loosening of monetary policy very cautiously (…) because inflationary pressures are obviously falling,” he said in an interview with the weekly Ekonom.
“Judging by the development of economic data and the communication of the members of the bank board themselves, it seems most likely that interest rates will be cut by a quarter of a percentage point already at the pre-Christmas monetary meeting,” comments Michal Skořepa, economist at Česká spořitelna. And he is joined by other experts who approached SZ Byznys.
Jakub Seidler, Chief Economist of the Czech Banking Association, sees it similarly. “Postponing to the beginning of February, when the CNB will not yet know the January inflation anyway, would not bring too much additional information, and in my opinion, the Bank Board would not want to postpone the first step until the next meeting at the end of March in light of the latest developments,” he explains.
The uncertainty surrounding the January inflation, which will also set the level for the entire next year, is the main argument for Komerční banka economist Martin Gürtler that the Bank Council will wait until February with the first rate cut. “Although the January inflation figure will be known only after the date of the CNB meeting in February, the central bank will already have certain indications about the development of prices and wages at the beginning of 2024,” he says.
Economists generally agree that the decision will be tight. Cyrrus portfolio manager Tomáš Pfeiler expects the first rate cut on Thursday. At the same time, however, he believes that this step should only happen in March. According to him, it is necessary to take into account the current level of inflation as well as the cumulative increase in the price level from recent years, despite the less vital domestic economy.
“Certain factors such as the rise in food prices should also motivate the CNB to exercise caution. If the CNB wanted to demonstrate its determination to really beat inflation, it should wait until the reduction,” Pfeiler thinks.
Within a year on four
Whether the central bank cuts rates in December or next year, one thing is very likely, according to economists. The base interest rate will be at a level of around four percent in one year’s time, unless new risks arise that would require a change in monetary policy.
The CNB’s bet on a drop in interest rates is also reflected in a drop in market rates for instruments with maturities of three to 10 years, or long-term rates. This downward movement allows banks to lower mortgage rates. And some banks are already taking these steps.
The interest rate on newly granted mortgage loans in November fell slightly from 5.71 percent in October to 5.67 percent and is the lowest since July last year, according to data from the Czech Banking Association. Despite the aforementioned developments, however, mortgage rates remain above-average high from the perspective of the last two decades and were at similar levels to the current ones in 2008 and 2009.
Economists attribute the sharper decline in CNB rates to the weaker performance of the domestic economy. “It will drop slightly this year, while next year it should grow, but probably still relatively slowly,” says Gürtler from Komerční banka.
“One can imagine a reduction of a quarter, a maximum of half a percentage point in one meeting,” estimates economist Seidler from the banking association.
Skořepa from Česká spořitelna also agrees with the scenario of a faster decline in interest rates. According to him, the condition is that January does not bring dramatic price increases. “The result should then be a total reduction of the repo rate by the end of 2024, possibly up to four percent,” he says.
Jaromír Šindel, Citibank’s chief economist for the Czech Republic, sees it similarly, according to whom the CNB is determined to reduce the main interest rate by a quarter of a percentage point to 6.75 percent on Thursday. “The central bank will subsequently cut its interest rate next year by 0.75 percentage point in each of the first three quarters and then by half a percentage point to a final four percent at the end of 2024,” he predicts.
Pfeiler from Cyrrus points to exaggerated market expectations, which currently predict a drop in interest rates by 2.6 percentage points, i.e. above four percent, in the one-year horizon.
“This has to do with the fact that investors, including those following major central banks, are placing disproportionate confidence in the expected sharp easing of monetary policy. If the scenario of the continuation of the disinflation process comes true, the rate will be closer to five percent at the end of 2024,” he concludes.