CZ: Service sector price inflation remains very high

In November, the price level in the Czech economy rose by a modest 0.1% month-on-month, keeping year-on-year inflation at 2.8%. Although November's figures are below both our and market expectations (0.2% month-on-month and 3.0% year-on-year), there has been no significant change in the inflationary trend. Several pro-inflationary factors persist in the Czech economy, including low unemployment, wage growth, service sector price developments, agricultural prices, expansionary fiscal policy, and the koruna's exchange rate. Conversely, the weak macroeconomic performance in Germany (eurozone) exerts a counteracting influence.

In December, inflation is expected to rise slightly above 3%, surpassing the upper limit of the tolerance band around the inflation target. However, this development will partly be due to the comparative base, and we view this anticipated movement as temporary. In January, inflation is expected to slow again, with a projected rate of 2.7%. Overall, service prices, reflecting a strong labor market and a recovery in household consumption, along with fiscal policy and the koruna's exchange rate, will likely continue to exert pro-inflationary pressures. A significant uncertainty, in both directions, will be the development of food and energy prices.

Over the next two years, inflation is expected to average slightly above 2%, driven primarily by the ongoing economic recovery and a strong labor market, particularly wage growth. However, inflation could remain volatile from month to month. A potential risk is the introduction of tariffs in international trade, which could increase inflation. For the years 2024 to 2026, we anticipate average inflation rates of 2.5%, 2.5%, and 2.3%, respectively.

The CNB anticipated November inflation at 2.9%, which is only slightly different from the actual figure. Inflation remains elevated near the upper limit of the tolerance band, with service sector price inflation still very high (5.2%), and recently released third-quarter wage data exceeding expectations. Additionally, the koruna remains weak. Therefore, we continue to expect the CNB to maintain stable rates at the December meeting, although the probability of a rate cut is only slightly lower, in our view. The CNB will likely consider both options.

We currently anticipate the next rate cut at the May meeting, while the market expects February. Overall, we foresee only very gradual rate reductions towards the 3% level over the next two years.

Today's data do not alter the overall view of price developments in the Czech economy, so we do not expect significant movements in the koruna's exchange rate. However, a slight weakening cannot be ruled out, given that the November figure was slightly below market expectations.