CZ: Increase in food and recreation prices

In July, the Czech economy experienced a 0.7% month-on-month surge in its price level. Consequently, annual inflation rose to 2.2%, marking a modest increase from June's figures. The relatively significant monthly inflation can be primarily attributed to a hike in holiday prices, a typical seasonal effect for this period. Additionally, a rise in service prices was observed, indicative of robust household demand.

June's unexpectedly low inflation was partly due to the unusual decline (after seasonal adjustment) in holiday prices, despite robust household demand. However, an opposite development (6.0% m/m growth of consumer prices in recreation and culture) occurred in July, supporting our hypothesis that June's anti-inflationary data may have been influenced by monthly data volatility. Indeed, food prices, which saw a month-on-month increase in July following a dip in June, also underwent a correction. Concurrently, service prices maintained a relatively high growth rate, propelled by a resurgence in consumer demand.

We anticipate a modest inflation slightly over 2% in August, although the level of uncertainty is expected to remain high. This is particularly applicable to food prices, which, due to their inherent volatility, could potentially surprise in either direction. Inflation may then experience an uptick in September, ranging between 2.5% to 3.0%, partially influenced by the base effect.

We project a more noticeable headline inflation towards the year's end, potentially surpassing 3% in Q4. This is attributable to last year's low base and the influence of various inflationary factors, including consumption recovery and wage growth. Developments in Germany introduce an element of uncertainty, as a delayed recovery in the German economy could suppress headline inflation in Czechia. Over the forthcoming two years, we anticipate inflation to average slightly above 2%, with the ongoing economic recovery and a robust labor market, particularly wage growth, exerting an inflationary impact. For 2024, 2025 and 2026, we now expect the headline average inflation to come in at 2.5%, 2.5% and 2.2%, respectively.

The Czech National Bank (CNB) has not provided significant information ahead of the September meeting, leaving a likely decision between rate stability and a further rate cut. Factors such as robust wage growth, expansionary fiscal policy, and anticipated Q4 inflation suggest possible stability. This is reflected in the CNB's new forecast, which does not project further rate cuts this year. However, weak GDP growth in both the Czech Republic and the euro area, the disparity between expected inflation and rates (implying a need for a more moderate rate reduction), and the anticipated rate cuts by the ECB and Fed in the coming months, all point towards a potential rate cut. We are inclined towards the latter, forecasting a 25 basis point reduction in CNB rates for September.

We project the CNB's key rate to stand at 4% by the end of this year, with a risk of either 3.75% or 4.25% contingent on new data, and 3.25% by the end of 2025. Given the robust labor market and anticipated economic recovery, demand inflation pressures will likely persist, resulting in an inflation rate between 2% and 3%. This will heighten the CNB's prudence. Uncertainty arises from external developments and from energy and food prices, which could significantly influence inflation in either direction, thereby impacting monetary policy decisions.

The koruna could experience a slight appreciation following today's events, as inflation marginally exceeded both market and CNB expectations.