The Czech National Bank (CNB) raised the key interest rate by 75 basis points to 1.50 percent. This is the most significant increase in interest rates since the beginning of the inflation targeting policy in 1997. It was 4.1 percent in August, one percentage point above the current forecast and more than double the middle of the target range. It was the accumulation of pro-inflationary risks that could act as the main argument for the Bank Board for such a sharp increase in the rates on which the prices of loans to companies or consumer and mortgage loans are based in the Czech Republic. The markets did not anticipate such a large increase in the key interest rate (two-week repo); the estimate was for an increase of half a percentage point.
After announcing an unexpectedly steep decision by the CNB, the koruna jumped to a two-week high of 25.288 per euro, trading 0.9 percent stronger than at the end of Wednesday’s session.
At the same time, the CNB decided to increase the Lombard rate by 75 basis points to 2.50% and to raise the discount rate by 45 basis points to 0.50%. The newly set interest rates are valid from October 1, 2021. Today’s main two-week repo rate will rise to its highest level since March 2020, when the central bank began cutting rates to help the economy hit by the first wave of the covid-19 pandemic.
The last forecast from the beginning of August called for a more aggressive rise in rates. It anticipated an increase of 50 points at the August meeting and a further increase at each subsequent meeting this year, but the majority of the Bank Board took a more moderate step in August. The CNB will present the new forecast at its next meeting in November. “The direction is more or less clear, we will continue in the direction of raising rates,” said Governor Jičí Rusnok when asked by Patria Finance. To say now how quickly and how often the central bank will continue to normalize monetary policy would, according to him, now be a sideways shooting. The pace of further tightening of monetary policy will be conditioned by future developments and the message of the autumn forecast, the central bank stated today. According to some analysts contacted by Reuters before today’s decision, base rates could be as high as 2 percent at the end of the year.
The CNB now sees the risks to the current summer forecast as significantly pro-inflationary. They therefore require a faster increase in interest rates compared to the current forecast. The CNB sees unexpectedly higher domestic inflation during the summer months as pro-inflation risks, including the longer duration of the increased contribution of owner-occupied housing costs to headline inflation. Furthermore, there are difficulties in global production chains and a weaker entrenchment of inflation expectations in a situation where inflation is overshooting its target in the long run. Five of the seven members of the Bank Board raised their hands today to raise rates by 75 basis points, two of which were in favor.
Arguments for an increase of 75 points pointed out that rates need to return to a neutral level, said Jiří Rusnok when asked by journalists. In our opinion, the economy no longer needs monetary stimulation, it would contribute to the overheating of the economy, he also noted. According to him, the CNB will not accept the fact that inflation expectations will take root in the Czech Republic at other stages of the economic chain. “Our inflation is therefore driven not only by external influences”, but also by the reaction of domestic entities to this development, in the context of a tense domestic labor market, Rusnok added. The CNB’s current forecast continues to expect inflation to gradually return to the 2% inflation target next year.
In June this year, the CNB was one of the first in the European Union to begin a cycle of tightening monetary policy as the domestic economy began to recover and inflation accelerated. In the last two sessions, it always raised the main rate by only the standard 25 basis points.
Banks have already stated in a ČTK survey that they will not respond to today’s decision of the Czech National Bank to sharply increase interest rates by raising prices immediately or raising interest rates on deposits. However, some smaller banks have already announced today that they will soon make higher interest rates on deposits.