CZ: Inflation driven by food and service prices

According to a preliminary estimate, prices in the Czech economy rose by 0.2% month-on-month in February. Year-on-year inflation reached 2.7%, only slightly down from January. The data align with market estimates and are slightly above our forecast (2.5%). Inflation thus remains elevated, near the upper limit of the tolerance band around the inflation target (3%), driven upward by food and service prices.

Detailed component data are not yet available. In the "food, alcohol, and tobacco" category, prices corrected after a significant increase in January, decreasing by 0.7% month-on-month. In our forecast, we expected a -1.0% change, which explains part of the difference between our forecast and the preliminary estimate. Year-on-year inflation in this group is 4.7%, remaining one of the main inflationary factors in the Czech economy. The second factor is service prices, which rose by a substantial 0.7% month-on-month, exceeding our expectations (the other part of the difference between our forecast and the actual data). The significant increase in service prices is partly driven by seasonal effects and the pass-through of higher food prices to restaurant prices, as well as recovering demand (holidays, rent, restaurants), signaling to the CNB the need for caution in setting rates.

In March, inflation could remain at a similar level to February. However, much will depend on food prices, which are volatile and have recently had a significant impact on inflation. Similar to last year, inflation is expected to be quite volatile from month to month this year. This may already be evident in April, when inflation could drop to around 2%, primarily due to the base effect. In subsequent months, it is expected to strengthen again.

For this year, we expect average inflation to be around 2.5%. Service prices will likely continue to drive price growth, supported by favorable labor market conditions. Conversely, the subdued developments in Germany (with its expected gradual recovery unlikely to be inflationary) and the CNB's monetary policy, which is likely to remain restrictive, will exert downward pressure. Similar factors are expected to influence inflation in 2026 and 2027, although inflation could be closer to the target. For all these years, we see heightened uncertainty, particularly regarding food and energy prices, which is bidirectional.

Potential trade disputes between the US and the EU present a bidirectional risk, with an unclear impact on inflation (and thus monetary policy). An increase in tariffs would, in itself, push inflation higher, but any further deterioration in the German economy, which would likely follow, would have an anti-inflationary effect. Therefore, in our view, inflation could strengthen in the short term but weaken in the medium term.

The CNB meets on March 26 and will likely decide between maintaining stable rates and a slight 25-basis-point cut. We continue to lean towards rate stability, though a rate cut would not be a major surprise. We currently see the probability of both options as relatively similar, with macro data (in addition to February inflation, also wages and the koruna's exchange rate) and other events (tariffs, developments in Germany) in the coming weeks potentially being decisive.

Today's data, in our view, increase the likelihood of maintaining stable rates, as the strong growth in service prices (and thus core inflation) is significantly driven by domestic demand (primarily the recovery in household consumption). We still expect two rate cuts this year (August and November) and an additional one next year. However, uncertainty remains high.