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Cut above the rest

ČR's interest rates above the eurozone's for the first time since 2002, but not for long, analysts say

By Claire Compton
Staff Writer, The Prague Post
December 10th, 2008 issue

ISIFA
The European Central Bank (ECB) announced dramatic interest rate cuts at a Dec. 4 Governors Council meeting in Brussels. ECB President Jean-Claude Trichet (above) attributes the recent decline in inflation to a fall in commodity prices and the slowdown
BRUSSELS
The distinction of having the lowest interest rates in the European Union was stripped from the Czech Republic Dec. 4, as the national banks of the United Kingdom and Sweden and the European Central Bank (ECB) announced dramatic rate cuts, exceeding even analysts’ predictions. On the same day, the Czech National Bank (ČNB) board held interest rates steady at 2.75, declining to act further after a 75-base-point cut in early November.
For the first time in its 10-year history, the ECB lowered the rate 75 base points to 2.5 percent, as the Bank of England lowered its own rate to 2 percent from 3 percent, a level not seen since World War II. Sweden’s rate also stands at 2 percent, after a 1.75 base point cut.
ECB President Jean-Claude Trichet, in uncharacteristically strong language, said the decline in inflation was due “mainly to the fall in commodity prices and the significant slowdown in economic activity. … All in all, the level of uncertainty remains exceptionally high.”
While the ČNB board held rates steady at the Dec. 4 meeting, analysts have roundly forecast continued ČNB cuts through next year, as plummeting commodity and oil prices and declining growth has meant inflation has slowed at a much faster rate than economic forecasts initially predicted. The next cut will likely be made at the bank’s Dec. 17 monetary policy session, according to comments made to Reuters by board member Robert Holman, in response to the cuts by central banks Dec. 4.
“With regards to what key central banks in Europe and in the world did, and to the fact that the ECB’s monetary policy rate is already lower than ours, I consider it quite likely that there will also be an interest rate reduction here,” he said, although he would not guess as to how much.
The imbalance in interest rates has a negative effect on exchange rates for the crown, the Atlantik group’s Chief Economist Petr Sklenář said, which is one of the most crucial challenges for monetary policy.
“I think they will cut interest rates at least 25 basis points for the next year. I expect that’s going to be enough and interest rates in the Czech Republic could be flat at 2.5,” he said. “While it’s expected the Czech economy will slow down, we will still grow in the next year by something between 2 and 3 percent.”
Inflation rates sink
But, as Trichet noted of the eurozone economy, the forecast for the Czech Republic is similarly difficult to predict at this moment, Sklenář added, and he would not exclude the possibility that the ČNB would need to reduce rates to as low as 1.75.
“If the recession in the eurozone is deeper and longer than expected, it will definitely hurt the Czech economy, and the ČNB will have to take adequate steps.”
Trichet cited Eurosystem staff projections that eurozone growth would slow to between negative 1 percent to zero percent for 2009 before increasing to between 0.5 and 1.5 percent in 2010. The ČNB forecasts economic growth in the Czech Republic to be at 2.9 percent next year.
Inflationary pressures have decreased dramatically in both the eurozone and the Czech Republic in response to plummeting commodity prices, specifically of oil. From its high of $147 a barrel in July, oil has fallen to $44 a barrel as of Dec. 9, a drop of nearly 70 percent in only five months. The price is expected to stabilize as a result of stimulus packages and output cuts being considered by the Organization of Petroleum Exporting Countries.
In the Czech Republic, inflation numbers that were released Dec. 8 showed that the rates are falling toward the ČNB’s target ceiling faster than expected. Year-on-year inflation in November was 4.4 percent, 1.1 percentage points lower than the bank’s forecast and a record fall in price of 0.5 percent from the month before. The ČNB’s inflation target is currently set at 3 percent; as of 2010, that target will be reset to 2 percent, in line with the ECB’s definition of price stability as “less than 2 percent, but close to 2 percent,” Trichet said. Eurosystem staff projections peg eurozone inflation to sink to an average of 1.1 percent to 1.7 percent next year, down from 2008’s 3.2 percent to 3.4 percent. The Czech Republic’s rate of inflation is projected to sink to 2 percent.

Claire Compton can be reached at ccompton@praguepost.com


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