Economist: Huge risk of even higher inflation

Fuel prices are continuing to rise and have already reached historic highs in the Czech Republic. The government has therefore decided to abolish the mandatory blending of bio-components into fuels and also to abolish the road tax on vehicles weighing up to 12 tonnes. But is it enough? And how will inflation impact the country’s industry and its citizens? I put these questions to Jan Vejmělek, chief economist at Komerční banka.

“Maybe I can start with a brief description of how important energy prices are for the Czech economy. The Czech Republic is an industrial country and has one of the highest industry per GDP shares in the European Union. Unfortunately there is quite a high level of energy intensive production here, which in turn means that the rise in prices means a huge rise in costs for Czech manufacturers.

“The rise in prices means a huge rise in costs for Czech manufacturers.”

“Furthermore, if we consider our geographical location, transportation is a significant part of the economy. I would also say that this counts for households. The share of Czech prices on expenditures is around 3 percent and for energy prices around 10 percent, is it definitely is a big issue.

“I would welcome any steps taken by the government. However, I am not a fan of direct government intervention in market prices, such as in the form of setting a cap on prices. For example, when it comes to the tax reduction [on passenger cars and vans weighing up to 12 tonnes approved by the government on Wednesday], we still have to keep in mind that this will have an impact on budget revenues and the state budget is currently not in the best condition in the Czech Republic.

Jan Vejmělek | Photo: Komerční banka

“Unfortunately, this sort of aid is not targeted, it is a general lifting of the road tax. Personally, I would prefer to see more direct support aimed at heavily impacted households or selected companies. By that I mean direct financial aid.

“But back to your question, I expect at least a partial stabilisation to fuel prices in the short term. This is more likely not just due to the steps taken by the government yesterday, but mainly due to the situation on the markets.  We can see some stabilisation took place yesterday. There was a significant drop in oil prices on Wednesday.

“There is a huge risk that inflation will continue to rise in the coming months.”

"Furthermore, the Czech crown is growing in value not just against the euro but also against the dollar.  Therefore, from a short term perspective, I would expect a stabilisation of our fuel and petrol prices. From a more long term perspective I would say it very much depends on how the situation in Ukraine develops.”

On another note related to the economy, inflation has been steadily rising since last year and reached 11.1 percent in February. The Czech National Bank (CNB) has been raising interest rates very high to tackle this issue. How is the war in Ukraine impacting the attempts to stabilise the crown, because inflation was rising sharply already before it broke out?

Photo: Štěpánka Budková,  Radio Prague International

“Yes, that’s the point. The figure you mentioned, 11.1 percent, is the first double digit growth recorded since 1998. It is true that such a price increase started mid-way through last year and the figure is not a consequence of the war in Ukraine. However, we will certainly see its impact during the months ahead. There is a huge risk that inflation will continue to rise in the coming months and 12 percent is a possible figure.

“We expect that the Czech National Bank will announce a further interest rate rise by 0.5 percent.”

"Regarding the actions of the Czech National Bank, our central bank was one of the first to raise interest rates last year and was quite aggressive in doing so, especially during the last two quarters. I think that we are close to the peak as far as the level to which the CNB is willing to raise interest rates.

"However, based on the current situation, I would expect some more slight adjustments. We expect that the Czech National Bank will announce a further interest rate rise by 0.5 percent after the next meeting of its board, which is expected to take place at the end of March.”

With the high influx of Ukrainian refugees, do you expect labour shortages to go down and unemployment, which has been at an EU low for years, to rise? What sort of effect will this have on the Czech economy?

“It’s possible that after more than a decade we will face a decline in real wages and revenue.”

“You are right in saying that the Czech labour market was overheated and it has been a long term issue in the Czech Republic. Even before the crisis in Ukraine there was a significant amount of Ukrainian workers employed in Czechia, especially in industry. Since there are a lot of vacancies right now on the Czech labour market, I guess it could happen that the influx of refugees from Ukraine will help to fill this gap.

"However, this will take some time. The short term impact could be negative, but from a medium term perspective I expect that it could help. Of course it should also be taken into account that in the past we mainly employed men, now there is a high share of women among the Ukrainian refugees that are coming in. In any case, facing this refugee wave is not a serious problem for the Czech labour market.”

How bad do you think times are going to get for the ordinary Czech, given the economic fallout from the coronavirus pandemic and now the war in Ukraine?

“It’s possible that after more than a decade we will face a decline in real wages and revenue. This year will be quite tough for the average Czech household, mainly due to high inflation which is rising faster than the growth of salaries. It will certainly have some impact on Czechs’ typical consumption habits.”