Inflation outpaces expectations

The inflation rate has overtaken forecasts, pushed up by commodity prices and spurring speculation about whether the Czech National Bank (ČNB) will increase its crisis-level interest rate sooner than expected.

Inflation hit 2.3 percent in December, up from 2 percent in November and higher than the 2.2 percent that economists had forecast. The increase was driven by higher food and fuel prices as well as higher demand for exports, economists said, but experts disagree about whether inflation has peaked or if higher rates will continue.

At their most recent meeting on the interest rate, ČNB board members were uncertain as to whether the factors that pushed up the rate were strong enough to justify increasing the interest rate. The central bank chose to keep the two-week repo rate at the recession low of 0.75 in its most recent vote Dec. 22, with Chief Executive Director Eva Zamrazilová as the sole dissenting vote, which she has maintained since October.

When Zamrazilová first voted to increase the rate, she told The Prague Post she saw signs that the economic recession was over and pro-inflationary pressures and commodity price increases emerging.

"Too-low rates for too long may create risks for financial stability in the future, even if this doesn't seem a very pressing problem at the moment," she said.

ČNB Governor Miroslav Singer acknowledged after the Dec. 22 vote the upward push of commodity prices and said that although wage growth remains weak, anecdotal evidence indicates there are companies that have begun to expand again. However, he said, uncertainty about the economy continues to outweigh the pressure from pro-inflationary factors.

"They are capable of potentially materializing into relatively large risks that will force us to make some changes earlier than we now expect in line with this forecast - upward or downward, I should add," he said.

Also adding to the uncertainty is GDP growth, which exceeded expectations at the end of 2010 with 2.8 percent annual growth, 0.1 percentage point higher than expected, but is forecast to slow in 2011 because of austerity measures.

Economists also remain divided about whether the bank will raise the interest rate sooner than last year's forecasts, which predicted the rate would probably remain stable until the fourth quarter of 2011.

Česká spořitelna, Raiffeisenbank and Société Générale analysts in research notes echoed Singer's position that it is too early to be concerned about commodity price increases and that certain factors negated improvements in the economy.

"We expect inflation to peak at the beginning of this year for the first few months at 2.4 percent," Raiffeisenbank analyst Pavel Mertlík told The Prague Post. "We don't see any demand that would make inflationary pressures go up faster than the ČNB expected. ... There won't be too strong domestic demand because of growing unemployment. Increased hiring in companies will start to take effect in the coming years, but not now."

Unemployment hit a high of 9.6 percent in December, and the job market took another hit when austerity measures went into effect Jan. 1.

Hike on the horizon?

Other analysts countered that the acceleration of price increases had the potential to force the ČNB to hike rates sooner.

"Fears about the impact of accelerating prices on inflation expectations can bring the first rate hike closer," said David Marek, chief economist at Patria Finance, but added that, in his opinion, the inflation rate is very low.

"If we adjust the consumer price index for tax changes and exclude energy and food prices, we can find that core inflation remains deep in the red," Marek said.

Even more hawkish on the market was Petr Sklenář, chief economist at brokerage firm Atlantik FT, who said the bank might be forced to raise the interest rate as soon as within the next two meetings of the bank.

"I expect there could be an increase of 0.75 to 1.5 or even to 1.75 [percent] by the end of the year," he said.

Although the possibility of a hike currently appears to be a minority opinion among economists, investors have gotten the jitters, prompting the first sale of floating-rate debt bonds since 2009 this month. (Floating-rate debt is a long-term government bond for which the interest rate is adjusted every six months.) The sale was part of an auction held by the Finance Ministry Jan. 12 that raised almost 6.4 billion Kč, according to the ČNB. The debt will mature in October 2016.

"You buy floating-rate bonds when you are afraid the market yields will go up. If you had a fixed-coupon bond, you would lose money because you would buy it at a rate of, let's say, 4 percent, and then the market yield might go up to 5 percent," said Anne-Francoise Blüher, economic and strategy research specialist at Komerční banka.

Blüher said to cater to those fears and to avoid selling more short-term bonds, which are less profitable, the Finance Ministry began to sell the floating-rate bonds to cover the deficit.

"The Finance Ministry is trying to find the bonds where they can expect some demand from the investor side," she said.

There are a number of pro-inflationary factors that are driving the inflation increase and speculation about an interest rate hike - mostly significantly, the increase in food and fuel prices. Food and nonalcoholic beverage prices have increased 5.6 percent year on year in January, according to the Czech Statistical Office, while automotive fuel prices went up 16.6 percent on the year.

The combination of higher fuel and electricity prices and a shortage in cereal stocks caused by last year's bad harvest could push food prices up 10 percent on the year, according to Dana Večeřová, a spokeswoman for the Federation of Food and Drink Industries of the Czech Republic.

"Food manufacturers are no longer able to absorb the increase in input prices," Večeřová said. "The most energy-intensive sectors, like bakeries, will suffer the most."

In addition, increasing demand for exports has pushed price growth, including of goods like Škoda automobiles, but most significantly of food, according to Sklenář.

"The main reason for this increase is positive economic development in developing countries and emerging markets, which causes their food consumption to increase," he said. "On the other hand, in the developed world, it's mainly about the corn for support of biofuels, and there are low levels of stock compared to consumption."

Sklenář also cited increased prices for agricultural commodities because of last year's bad harvest as a reason for higher food prices.

Cat Contiguglia can be reached at
ccontiguglia@praguepost.com