Weekly Briefing, Vol. 62. No. 2 (CZ) May 2023
Inflation and the Risk of a Wage-Price Spiral
Summary
The Czech economy sends ambiguous signals to the economic subjects. Inflation decreased to 12.7 per cent in April compared to 18.0 per cent in November 2022. The Czech National Bank as the state body responsible for handling inflation kept the basic interest rates without any changes but appealed to the government to carry out fiscal reform. The national currency continues to strengthen which contributes to weakening pro-inflationary factors. At the same time, the predominantly good financial condition of enterprises, which is also secured by extensive state subsidies and financial transfers, enables firms to increase wages and prevents the loss-making subjects from going bankrupt. It results in virtually full employment.
Introduction
Inflation remains to be one of the main problems of the Czech economy. Nevertheless, the recent data regarding the development in the field in April brought positive results that indicate a gradual decrease in the index of consumer prices. At the beginning of May, the Czech National Bank decided to keep the basic interest rates unchanged but warned that the monetary policy would be made more restrictive in the following months if the negative tendencies persist. The governor of the central bank and the prime minister subsequently clashed with each other over the causes of the galloping inflation in public.
Cooling inflation
The year-on-year inflation rate fell from 15.0 per cent in March to 12.7 per cent in April. This decrease was strongly affected by lower prices of food, beverages, fuels and some services. The prices of food were even below the March level which was their first month-on-month decrease since October 2021. On the contrary, inflation was pushed up by articles of daily use. In terms of year-on-year comparison, the overall decrease in the growth of consumer prices is caused by the development in the field of food, nonalcoholic beverages and expenses on housing. Despite that, the prices of electricity, gas and heat increased by 24.8, 53.1 and 40.9 per cent respectively compared to the situation in April 2022. If one takes into account the prices of water rate, sewer rate and solid fuels which raised by 16.3, 30.3 and 47.6 per cent year-on-year respectively, it becomes clear that the overall expenses on housing soared considerably. All the more that the rental as well as interest rates on mortgages went up at a rapid pace too. From the interannual perspective, the prices of goods were increasing more than those of services (14.5 and 10.1 per cent).[1] The table below sums up the inflation dynamic over the last months (the figures are in %):
It turns out that the April figure is identical to that detected in March 2022. The recent decrease reaffirmed the tendency which began at the beginning of this year. It is also worth noting that the inflation target set by the Czech National Bank (CNB) on 2 per cent was reached in December 2018 for the last time. Since then the rate has been only higher.[2] The inflation was typical of volatility in the last months and surprised economists as well as central bankers several times. The recent development has been in accordance with the predictions of the CNB. The bank expects that the inflation rate will decrease below 10 per cent by mid-2022 and get close to the 2-per cent target by the mid-2023.[3]
Strengthening Czech currency
At its meeting at the beginning of May, the CNB’s Bank Board decided to maintain the existing interest rates without any changes. It means that the 2W repo rate amounts to 7.00 per cent, the discount rate is 6.00 per cent while the Lombard rate equals 8.00 per cent. All these rates were set in June 2022. Nevertheless, the central bank conveyed an ambiguous message as far as the basic interest rates are concerned. The point is that there are both pro- and anti-inflationary factors at the moment. The government’s expansive fiscal policy, the risk of wage-price spiral, overheated labour market and lingering inflation expectations belongs to the former whereas the cooling consumer and investment demand to the latter. The development will be strongly affected by the war in Ukraine, prices of energy and monetary policies abroad.[4] The CNB considers the current level of interest rates sufficient despite the loud voices of some economists and politicians that the rates should be raised again to counter inflation. The incumbent Bank Board has never increased the rates and preferred the strengthening of the Czech currency instead. The national currency strengthened by 3 per cent to EUR in 2022 and became the most dynamic one in the CEE region. This year the koruna strengthened by a further 3.5 per cent to EUR and reached the level of 23.271 CZK/EUR on April 13. While before the pandemic the rate oscillated around 25 CZK/EUR, it depreciated to 27.635 CZK/EUR in the second half of March 2020. The following table shows the high volatility of the Czech koruna over the last four years and its conspicuous strengthening since the pandemic heights.[5]
The strengthening is caused by a high interest-rate differential, positive sentiments in the capital markets and indications of the decrease of the galloping inflation. Moreover, the CNB was intervening in the exchange rate by selling its extensive foreign exchange reserves. It is, therefore, not excluded that the threshold of 23 CZK/EUR will be overcome in the following months. The koruna remains popular among investors because of the high yield and the position of the central bank which has repeatedly declared that it will not allow any considerable depreciation. These statements are, moreover, supported by the foreign exchange reserves at its disposal. Nevertheless, the trend can turn provided that the CNB starts to decrease the interest rates.[6] The chart below demonstrates the total volume of the foreign exchange reserves since 2018 and the drop caused by the central bank’s intervention in favour of the Czech koruna. While the peak was reached on February 28, 2022, when the reserves amounted to 181,696.51 billion USD, they fell to 139,436.82 billion USD by the end of April 2023 after the minimum of 130,344.61 billion USD on October 31.[7]
The strengthening of the currency, however, poses a problem to the Czech exporters who constitute the backbone of the national economy. It reduces profits on the part of producers, deteriorates their international competitiveness and decreases state tax revenues. Yet, the central bankers consider this policy positive as it weakens pro-inflationary pressures. Deputy Governor Eva Zamrazilová believes that the strong koruna makes the real basic interest rates higher than the nominal figures are.[8]
Overheated labour market
The record from the session of the May Bank Board indicates that the bankers are very careful about pro-inflationary factors. The problem of the overheated labour market was addressed. The unemployment rate decreased to 3.6 per cent in April and remains the lowest in the EU. There were around 284,500 job vacancies in contrast to 261,700 unemployed persons. Many of the latter do not want to work and abuse the social security benefits. The data corroborate that the Czech labour market absorbed dozens of thousand of Ukrainians without any problems and companies demand further labour force. Even the unemployment in the worst region (5.5 per cent) is below the EU average which was 6.0 per cent in March.[9] However, the long-term de facto full employment is rather negative in macroeconomic terms. It makes the companies increase wages excessively to keep their employees irrespective of labour productivity and overall efficiency, thus stimulating the wage-price spiral.
According to the central bankers, the growth of nominal wages oscillates around 10 per cent which is considered high-risk. The acceleration of interannual growth of wages is noticeable since the last quarter of 2021, covering virtually all sectors irrespective of the size of companies.[10] Enterprises have not been exposed to existential risks so far also due to massive state subsidies. The latter has distorted the market environment to such a high degree that the Supreme Audit Office has recently declared that the Czech economy has turned into an economy based on subsidies.[11] It prevents the loss-making companies from going bankrupt, thus keeping labour force in enterprises and industries that are not financially viable. A substantial reduction of subsidies and financial assistance to enterprises could, therefore, cool the labour market and lead to higher productivity.
Conclusion
Governor of the Czech National Bank Aleš Michl warned in May that the bankers would increase the basic interest rates if the growth of wages is too rapid and unless the government carries out a revision of its fiscal policy. The latter comment provoked a negative reaction from Prime Minister Petr Fiala who, in turn, criticised the central bank for inaction in countering inflation which is indeed the principal task defined by the constitution. From the point of view of the incumbent Bank Board, the cabinet has to prepare consolidation and austerity measures to reduce expenditures and the state debt.[12]
[1] Index spotřebitelských cen – inflace – duben 2023 (2023, May 11). Český statistický úřad. https://www.czso.cz/csu/czso/cri/indexy-spotrebitelskych-cen-inflace-duben-2023
[2] Míra inflace (2023, May 11). Český statistický úřad. https://www.czso.cz/csu/czso/inflace_spotrebitelske_ceny
[3] Král, P. (2023, May 11). Inflace v dubnu 2023 dále znatelně klesla a nacházela se mírně pod prognózou. Česká národní banka. https://www.cnb.cz/cs/verejnost/servis-pro-media/komentare-cnb-ke-zverejnenym-statistickym-udajum-o-inflaci-a-hdp/Inflace-v-dubnu-2023-dale-znatelne-klesla-a-nachazela-se-mirne-pod-prognozou/
[4] Brůha, J. (2023, May 3). Záznam z jednání bankovní rady ČNB dne 3. května 2023. Česká národní banka. https://www.cnb.cz/cs/menova-politika/br-zapisy-z-jednani/Rozhodnuti-bankovni-rady-CNB-1683126000000/?tab=record
[5] Czech koruna (CZK) (2023, May 11). European Central Bank. https://www.ecb.europa.eu/stats/policy_and_exchange_rates/euro_reference_exchange_rates/html/eurofxref-graph-czk.en.html
[6] Rekordně silná koruna by mohla dále posílit, shodují se analytici (2023, April 16). Novinky.cz. https://www.novinky.cz/clanek/ekonomika-rekordne-silna-koruna-by-mohla-v-pristich-mesicich-dale-posilit-40428766
[7] Czech Republic Foreign Exchange Reserves (2023, April). Tradingeconomics. https://tradingeconomics.com/czech-republic/foreign-exchange-reserves
[8] Zamrazilová: Pokud se zvýší daně či mzdy, porostou i úrokové sazby (2023, May 4). ČT24. https://ct24.ceskatelevize.cz/domaci/3583596-zamrazilova-pokud-se-zvysi-dane-ci-mzdy-porostou-i-urokove-sazby
[9] Nezaměstnanost v ČR dál klesá, v dubnu dosáhla 3,6 procenta, zůstává nejnižší v EU (2023, May 10). ČTK. https://www.ceskenoviny.cz/zpravy/nezamestnanost-v-cr-dal-klesla-v-dubnu-o-desetinu-bodu-na-3-6-procenta/2362919
[10] Galuščák, K., Livorová, B., Ruschka, A. (2023, May 4). Analýza mzdové dynamiky v České republice. Česká národní banka. https://www.cnb.cz/cs/menova-politika/zpravy-o-menove-politice/boxy-a-clanky/Analyza-mzdove-dynamiky-v-Ceske-republice/
[11] Šéf NKÚ Kala: Naše ekonomika plíživě přešla z tržní ekonomiky do ekonomiky silně závislé na dotacích (2023, April 3). iROZHLAS. https://www.irozhlas.cz/ekonomika/nejvyssi-kontrolni-urad-vyrocni-zprava-dotace-deficit-zadluzovani_2304030700_til
[12] Voženílek, L. (2023, May 3). Pokud vláda nezačne šetřit, zdražíme všem úvěry, varuje guvernér ČNB. Seznam Zprávy. https://www.seznamzpravy.cz/clanek/ekonomika-finance-ani-tentokrat-cnb-trhy-neprekvapila-hlavni-sazbu-ponechala-na-sedmicce-230293