1. Czech Koruna and the Economic Outlook
Vladimír Tomšík
Vice-Governor
Czech National Bank
Austrian-Czech Economic Forum
Czech National Bank Congress Centre
Prague, 27 June 2017

2. The CNB’s exchange rate commitment in retrospect
Outline
The CNB’s exchange rate commitment in retrospect
Recent economic developments and outlook
Future euro adoption in the Czech Republic

3. The CNB’s exchange rate commitment in retrospect
Outline
The CNB’s exchange rate commitment in retrospect
Recent economic developments and outlook
Future euro adoption in the Czech Republic

4. Background of FX Commitment Decision
In 2013, the Czech economy was going through the longest recession in its history, with decreasing household consumption, low investment, and inflation falling towards zero. CNB’s forecasts indicated possibility of deflation- recession spiral in case that monetary conditions would not be eased further.
The standard monetary policy tool, however, reached its limits, as the CNB had already kept interest rates at ”technical zero“ level for a year.
In the second half of 2013 CNB communicated that it was ready to use the exchange rate if a further monetary policy easing became necessary.
On 7 November 2013, the Bank Board adopted an one-sided exchange rate commitment (a ”floor“ set at CZK 27 to the euro).

5. Economic Recovery
The weakened exchange rate contributed significantly to the economic recovery that occurred in 2014 (together with recovery in external demand and with the end of restrictive domestic fiscal policy).
The revival of economic activity was even faster than predicted in November (in 2015 fostered by EU funds and the effect of oil price drop).
Deflation was successfully avoided; core inflation turned positive quite soon.
However, inflation reached the upper half of the tolerance band around the CNB’s 2% target two years later than originally envisaged due to external disinflation.
GDP (y/y in %)
Inflation (y/y in %)

6. External Deflationary Pressures
The commitment has been repeatedly prolonged due to deflationary pressures from abroad (including oil price drop in 2014 and 2015).
These pressures were reflected in domestic prices mainly through a deepening decline in foreign producer prices, and their delayed expected rebound back to positive growth rates.
Euro area PPI and its outlooks in CNB‘s forecasts (y/y in %, in effective terms)
The extension of the CNB‘s exchange rate commitment also partly reflected an intensifying easing of the ECB‘s monetary policy, responding to the subdued price developments in the euro area.

7. Exit from the Commitment
The commitment ended in April 2017 as conditions for sustainable fulfilment of the 2% inflation target in the future had been met.
The exit from the commitment has been smooth. The Czech koruna has been appreciating moderately since then.
CZK /EUR %

8. The CNB’s exchange rate commitment in retrospect
Outline
The CNB’s exchange rate commitment in retrospect
Recent economic developments and outlook
Future euro adoption in the Czech Republic

9. Inflation
Structure of inflation
(annual percentage changes; contributions in p.p.)
Inflation returned back to the 2% inflation target in December 2016, after being below it for four years. It has increased further this year (2.4% in May).
Core inflation has been higher than 2% in recent months (2.5% in May).
Food prices and fuel prices are also growing visibly in annual terms.

10. Economic Activity
GDP growth and its structure
(annual percentage changes; contributions in p.p., s.a.)
Output gap
(in % of potential output)
Domestic economic activity has been growing since late 2013, driven by stable growth in household consumption. The slowdown in 2016, caused mainly by a fall in investment as a result of the EU funds cycle, halted in Q4. GDP growth accelerated again in 2017 Q1 broadly in line with expectations.
The previous economic slack has been fully eliminated, the Czech economy is now operating close to its potential. The output gap is expected to stay close to zero in the period ahead.

11. General unemployment rate
Labour Market
Continued economic growth is also evident in the strong labour market:
growing employment and declining unemployment
accelerated nominal wage growth in both business and public sector
The Czech Republic currently has the lowest general unemployment rate among all the EU countries.
General unemployment rate
(in %, March 2017)
Eurostat

12. Latest Macroeconomic Forecast (i)
Inflation
(y/y, in %)
Interest rate (3M PRIBOR)
Inflation will stay in the upper half of the tolerance band around the 2% target this year and return to the target early next year.
Consistent with the forecast is an increase in domestic market interest rates in 2017 Q3 and later also in The rate increase will be strongly dampened until around mid-2018 by the ECB’s currently ongoing quantitative easing.
According to the forecast, the koruna will appreciate. However, the appreciation may be strongly dampened by market “overboughtness”.

13. Latest Macroeconomic Forecast (ii)
GDP
(y/y, in %)
Labour market
(y/y, in %)
The growth of the Czech economy will rise to almost 3% this year. The domestic economy will maintain a similar pace next year.
Growth will be driven mainly by robust growth in household consumption and a gradual recovery in investment. The economy will benefit from further growth in external demand.
The domestic economic growth will manifest itself in rising tightness in the labour market. This will result in a further acceleration in wage growth.

14. Monetary Policy
Interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna.
The CNB still stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed.
At its May monetary-policy meeting, the Bank Board assessed the risks to the inflation forecast as being slightly inflationary:
The path of the exchange rate is still the main uncertainty of the forecast.
possible fluctuations of the exchange rate in either direction
market “overboughtness”
Further uncertainties:
nature and persistence of the current inflation pressures
domestic and foreign political risks

15. The CNB’s exchange rate commitment in retrospect
Outline
The CNB’s exchange rate commitment in retrospect
Recent economic developments and outlook
Future euro adoption in the Czech Republic

16. EA Accession Strategy Strategy from 2003, updated in 2007:
Euro adoption is a political decision
Reasonable to adopt euro as soon as adequate conditions are created (fiscal side, structural reforms, etc.)
CNB will continue with inflation targeting before entry
Economic assessment of readiness for entry each year – not just Maastricht criteria, but also economic alignment analyses (prepared by the CNB and the Ministry of Finance)
Persisting low flexibility and efficiency of the economy (labour market) seen as a major obstacle
Euro-adoption target date will not be set (and ERM II membership will not be initiated) until sufficient progress is made in economic preparedness of the country to adopt the single currency
ERM II membership should be minimised (2 years + period for assessment)

17. Czech Republic – Maastricht Criteria 2015
Maastricht criteria, except ERM II, are at the moment (and in the outlook) fulfilled
Domestic fiscal situation is no more an obstacle to meeting the Maastricht criteria
Criterion (2015)
Value
Reference value
Fulfillment
Inflation
0.3%
(0.6%) 
Public deficit
0.6% of GDP
3% of GDP
Public debt
40.3% of GDP
60% of GDP
Interest rates
0.6%
(3,8%)
ERM II No 

18. Alignment of Economic Activity
Main indicators in favour of adopting euro:
high degree of openness of the Czech economy
the exports-to-GDP ratio is 83%
close trade and ownership links with the euro area
high degree of alignment of the Czech business cycle with the euro area
high correlations of overall economic activity and exports with the euro area (even when adjusted for crisis period)
Areas showing long-term problems or misalignment:
functioning of the Czech labour market (low flexibility)
quality of institutions, infrastructure and innovation
low price level convergence (low degree of real convergence reached so far)
long term ability of the fiscal policy to serve as a macro stabilizer + costs of ageing
GDP growth
(y/y, in %, s.a.)

19. Current Situation Concerning the Euro Adoption
„New“ factors to consider:
still unresolved problems in the EA, the situation of which cannot be assessed as sufficiently stabilised
new mechanisms and institutions coming into force fundamentally change the conditions and obligations arising from a country‘s membership in the euro area
The public support is now low; however, business representatives traditionally call for an early euro adoption.
There is currently no euro adoption target date set.
However, the debate on the euro adoption has been renewed on the political scene recently in connection with the upcoming general election later this year.

20. Thank you for your attention
Vladimír Tomšík
Vice-Governor