CZ: Demand-driven inflationary pressures remain elevated

Preliminary estimates indicate a 0.1% decrease in the price level for April, resulting in year-on-year inflation of 1.8%. This is unexpectedly low, as both our and market expectations were set at 2.1%. It's the lowest year-on-year inflation figure since March 2018.

The surprise is largely due to a significant correction in food prices, coupled with a decline in fuel prices. Apart from these supply-driven (and thus volatile) items, the broader inflation trend in the Czech Republic remains largely unchanged. The demand-driven component of inflation remains high, fueled by household consumption recovery, a strong labor market, and the current drop in fuel prices (leaving households with more disposable income for other purchases). The base effect also contributed to the inflation slowdown.

Detailed data on individual components are not yet available. Preliminary figures indicate a notable correction in the "food, alcohol, and tobacco" category in April, with prices dropping 0.6% month-on-month, slowing year-on-year inflation in this segment from 5.9% to 3.3%. Conversely, service prices, which more closely reflect domestic economic trends, continued to rise by 0.2% month-on-month, slightly increasing year-on-year inflation in the service sector to 4.7% (from 4.5%). In addition to food prices, April saw a significant decline in fuel prices, driven by lower oil prices. In this respect, lower oil prices significantly impacted year-on-year inflation in the "goods" category, slowing from 1.6% to 0.2%.

For this year, we anticipate average inflation around 2.6%. Service prices, driven by favorable labor market conditions, and food price trends will likely continue to support price growth. Conversely, global economic developmentssuch as low GDP growth in Germany and the negative impact of trade tariffs on demand and oil pricesand the CNB's likely restrictive monetary policy will exert downward pressure. Similar factors are expected to persist in 2026 and 2027, with inflation potentially closer to the target. Across 2025-2027, we see heightened uncertainty, particularly in food and energy prices, which is bidirectional.

The CNB meets tomorrow and will likely decide between maintaining stable rates or reducing them by 25 basis points. Today's unexpectedly low inflation figure significantly increases the likelihood of a rate cut. However, it's not certain, as demand-driven inflation factors in the Czech economy remain strong and are weakening only slowly in the medium term. Therefore, if the CNB cuts rates tomorrow, we don't anticipate a major shift in its communication, which may continue to emphasize the need for strict monetary policy.

If the CNB lowers rates tomorrow, it might keep them unchanged for an extended period, in our view, with the next rate cut expected at the November meeting.