Deflation continues but for how long?

Czech consumer prices dropped sharply beyond market expectation in September. The Czech Statistics Office said prices in September were down 0.5 percent month-on-month, putting the year-on-year rate at 0.0 percent. Analysts had predicted that year-on-year inflation rate would reach +0.3 percent. I spoke to economic analyst Vladimir Pikora of the Prague branch of Volksbank about the main factors behind the latest development:

Deflation continues but for how long?

Price index, CTK

"The price index was significantly influenced by a more than 24-percent drop in prices of recreational stays and holidays abroad. Month-on-month inflation therefore remained negative. On the other hand, we saw an increase in prices of food and non-alcoholic beverages by almost one percent. Besides, oil prices continued soaring and expanded by 1.6 percent."

Food prices had been decreasing previously. Does this mean a turn in food prices development? Can we expect a further increase?

"Yes, exactly. We expect that the trend of food prices has changed and in the future, we will see a rapid growth and this will be the main motor of the CPI index. There will be also other factors, such as the withdrawal of 10- and 20 heller coins which will add stimulus to the growth of consumer prices as well. We expect that at the end of this year, inflation could be around one percent. We will see another increase at the beginning of next year when some taxes will be raised. We can therefore expect that in the middle of 2004, the CPI inflation will be around 3 percent."

The end-year inflation of one percent is below the Czech National Bank's target. Do you think the Central Bank will react to this trend or will it rather wait for the impact of the VAT increase?

"We expect that the Central Bank will not react. It is true that the CPI index is under the target. On the other hand, the Central Bank forecast in its latest prediction that the CPI will finish the year at around 1 percent. I think they will not be very much worried about it, because they expect the inflation to be between 0.7 and 1.4 percent. Besides that, there will be another factor -consumer credits. The Central Bank is worried about a constant and very rapid increase of the volume of consumer credits and another rate cut could speed up this trend. They are afraid that this could influence the banking system. That is why, I am afraid, this will be a factor that will prevent the Central Bank from cutting the rates."