Economist: Domestic trends also to blame for Czechia’s high inflation rate

Czech National Bank

The Czech National Bank (ČNB) has chosen to raise interest rates by 0.75 percentage points to 5.75 percent, the highest rate since 1999. The hike is also slightly higher than most analysts expected and some have even warned of a stagflation effect as high interest rates may cripple economic growth. To find out whether these concerns are justified, I spoke to Vít Hradil, the chief economist at the investment firm Cyrrus, and began by asking him whether he was surprised by the ČNB’s decision.

“I wouldn’t call it a surprise. I guess I was expecting a slightly smaller hike of 50 basis points and so was the market actually. I think that the whole financial market and all of the analytical institutions were expecting a slightly smaller hike.

“That said, I think that it’s actually not such a big surprise, because everybody knew that it was going to go up and they were expecting the end goal to be the interest rate set around 6 percent. Whether the Czech National Bank gets there through small steps or bigger ones doesn’t really make that much of a difference.”

How seriously should we take warnings about stagflation as some experts have warned? Should we be worried about strangling growth?

“Stagflation is probably a reality now. Even the Central Bank expects economic growth in the area of just around 0.8 percent, which is basically as good as stagnation. And we do have inflation. Again, the ČNB’s forecast calls for 13 percent on average for this year. So I think that we can safely call 2022 a year of stagflation.

“The worry really is whether we can get rid of it sometime soon, because a lot of it is due to temporary phenomena such as the war on Ukraine, or the pandemic which still shows up in the data.

“The only worry that I have now is whether we can get out of stagflation and just make it a temporary one-year-long phenomenon, or whether it’s going to stick around for longer.”

The Czech National Bank has been saying for some months now that the situation will start getting calmer towards the end of this year. That they will be raising interest rates sharply until the half of 2022 and that things will start getting back to normal after that. How realistic do you think this forecast is?

“Well, there are two things. As far as their own forecast is concerned, it is pretty obvious to anybody that they have been wrong for quite some time. They will always say that it is going to cool off sometime soon, but it just never did. So, in that sense, their own forecast failed to some degree.

Vít Hradil | Photo: archive of Vít Hradil

“However, I would defend them and highlight that they were not the only ones. This is an inflation that no one saw coming, so I wouldn’t really hold our central bank accountable for that. In fact, I would like to praise them for their foresight, because they were actually one of the first central bank’s in the whole of the Western world who started hiking rates sometime during the middle of last year and that was back in a time when no one was really worried about inflation. They definitely saw it coming and I would praise them for that.

“I would be a bit sceptical about whether it is going to cool off in the timeframe that they give at this point. Of course on the one hand they actually have to say that, because the communication of the central bank forms inflation expectations and has an effect on inflation at the end of the day, so I don’t blame them for saying that it’s going to get better soon even though they might not always believe it a 100 percent.

“I think that we certainly can’t expect normal inflation (meaning somewhere close to the 2 percent target) this year. I don’t expect it will happen next year either. If everything goes according to plan, I think that we will reach it only by 2024.”

The Czech Republic has had one of the highest rates of inflation among EU member states for several months now. Why is inflation higher here than in most EU countries?

“In this regard, there are a couple of Czech specifics that come into play. First of all, we were having inflation problems even before the pandemic began. In fact, I think that it was in the same month that the World Health Organisation officially declared a pandemic that we were still hiking rates, which was pretty rare in the Western world, because our inflation rate was approaching 4 percent back then. Of course it cooled off during the pandemic, but now, with the return to normal, our concerns about inflation are coming back. It is necessary to keep in mind that there were concerns about inflation in Czechia already before the pandemic.

“Why was that? Partly it is connected to our labour market. We have been having the lowest unemployment rate in the EU for, I think, several years now. What that leads to obviously is a lot of pressure on wages to go up and higher wages mean a lot of buying and prices going up.

“The second factor is the real estate market. The process of issuing a construction permits is ridiculously slow in this country. Czechs also have a preference for owning real estate rather than renting. This all means that there are a lot of price pressures coming from the real estate market as well and this is a phenomenon which has been present for the past 10 or 15 years.

“Finally, I would also add that [the cabinet of Andrej Babiš] was extremely generous during the pandemic. The amount of extra expenditure that we poured into the economy was, even by European standards, pretty high. These expenditures were also often not aimed at anybody in particular. It was a huge load of money that the government threw in and what that leads to is a lot of money among the population. At the same time, the whole production side of the economy was tamed due to the pandemic. So there was a lot of money flowing around a few goods and services being made, which in turn leads to inflation.”

If you had to pick a couple of main indicators that people should look out for in order to get an idea of how inflation is likely to evolve in the future, what would they be?

“First of all, and this is something that is completely beyond the control of the central bank, one should look at the prices of energy. That means mainly oil and natural gas.

“This is something that is obviously very closely related to the conflict in Ukraine. As soon as things start getting calmer there, I would expect prices to go down. They are unlikely to drop dramatically and will probably not go back to what they were before the conflict, but they should go down. Energy prices are obviously a good indicator for the whole economy and for inflation, because energy prices impact just about everything. So inflation should go down when energy prices start to fall.

“The second thing that I would look out for are any kind of measurements of inflation expectation. The Czech National Bank ran surveys among corporations, firms and analysts, so they have data on their inflation expectations. Then there are also the European Commission’s surveys of inflation expectations among ordinary people. All of these have been skyrocketing over the past couple of months. I think that once these start to get calmer, we should expect inflation to start dropping.”