CZ: Inflation affected by food prices

According to a preliminary estimate, the price level in the Czech economy increased by 1.3% month-on-month in January this year. Year-on-year inflation reached 2.8%. Compared to December, there was only a slight slowdown in inflation, which remains near the upper bound of the tolerance band around the inflation target (3%), and can thus be considered elevated.

We do not yet have the components of inflation, which will be available with the final figures. However, the Czech Statistical Office released preliminary values for some groups. In January, goods prices increased by 1.5% m/m, while services rose by 1.0% m/m. Prices in the "food, alcohol, and tobacco" category increased by a significant 3.5% m/m, which is the main reason for the surprise. Conversely, energy prices rose by only 0.2% m/m. From a monetary policy perspective, it is important that service prices continue to grow strongly (year-on-year slowdown from 5.0% to only 4.7%), which should encourage continued caution.

For the coming months, we expect inflation to range between 2.5% and 3.0%. However, heightened uncertainty remains, particularly regarding food prices, which can significantly influence the overall figure. Inflation in service prices is expected to gradually slow, yet it will remain elevated. Overall, we do not anticipate any significant changes in the trajectory of Czech inflation.

This year and next, we expect year-on-year inflation to remain slightly above the inflation target, although it may remain volatile from month to month. Domestic economic developments, with an anticipated acceleration in GDP growth and continued relatively strong household demand, will exert pro-inflationary pressures. Conversely, the weak macroeconomic conditions in Germany will have an anti-inflationary impact on the Czech economy.

Potential trade disputes between the US and the EU present a bidirectional risk, with an unclear impact on inflation. 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 opposite effect. Therefore, in our view, inflation could strengthen in the short term but weaken in the medium term.

The CNB meets today, and we slightly lean towards a 25-basis-point rate cut. However, this is not certain, as the CNB will likely choose between a rate cut and maintaining stability. Today's data slightly favor stability, but weak macroeconomic data from Germany in recent weeks push in the opposite direction.

Today's elevated inflation should support the CNB's cautious approach, which aligns, in our view, with our forecast that the next rate cut (if the CNB cuts rates today) would occur in August.

For this year, we anticipate three CNB rate cuts (February, August, and November) and an additional one next year. Risks are bidirectional; on one hand, if developments in Germany remain subdued throughout the year, the CNB may be prompted to lower rates more quickly. Conversely, a scenario where the bank board prefers to halt gradual rate cuts at a higher level (3.25% or 3.50%) cannot be ruled out.