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Czech central bank's Niedermayer says risks higher

Czech inflation risks have increased „slightly” after the koruna depreciated against the euro and the economy showed signs of growing faster than expected, central bank Deputy Governor Ludek Niedermayer said.

Annual consumer price growth, which rose to 1.5% in February, may be spurred by a weaker-than-expected koruna, the banker said in an interview on March 14 in Prague. The Czech currency has lost 2.4% against the euro this year. If „the current exchange rate development goes on, I see the risks slightly skewed to the upside,” Niedermayer said. „Right now, I think interest rates are where they should be,” which „opens the possibility of a rate movement in both directions.”

The koruna's gains last year pushed inflation below the central bank's 3% target, giving it room to leave the benchmark interest rate unchanged at 2.5%. The currency's weakness has put policy makers on the alert for signs of price growth underpinned by rising demand and tax increases. The central bank has raised interest rates three times since October 2005, by a combined 75 basis points, from a record-low 1.75%. A basis point is 0.01 percentage point. The koruna gained 2.9% against the euro in the Q4 and 5.8% for all last year before it recorded a „relatively strong” depreciation so far this year, the 41-year-old deputy governor said. The currency advanced to 27.85 per euro by 2:33 p.m. in Prague from 28.06 yesterday, a 0.8% gain to the strongest since January 19.

The koruna's level of around 28.20 per euro is a „relatively marked” deviation from what the central bank's January inflation outlook assumed, Niedermayer said. That forecast suggests keeping rates stable initially and increasing them gradually in the longer term. The central bank will announce its new inflation prediction on April 26. The koruna's strengthening has been stifled because Czech borrowing costs are less than those in the euro region, the banker said. The benchmark Czech two-week repo rate is 1.25 percentage points below the European Central Bank's main rate. Only Japan and Switzerland have lower interest rates than the Czech Republic.

Short-term swings in the exchange rate have been influenced by global investors' appetite for central European assets, the banker said, rather than by factors such as the so-called „carry trade,” whereby investors borrow in a low interest-rate currency and use the funds to buy higher-yielding assets elsewhere. The koruna's short-term movements are „led by changes of portfolios and asset allocations by large financial investors rather than by domestic economic factors,” he said. The annual inflation rate in February was about 0.3 percentage point lower than policy makers predicted, mainly amid an updated consumer basket. The bank targets inflation at 3%, plus or minus one percentage point. „By increasing the weight of” tradable goods, „the new consumer basket will push inflation down should the exchange-rate development be similar to previous years,” Niedermayer said.

The economy expanded 5.8% in the final three months of 2006, driven by the fastest-growing household spending in three years. Inflation-adjusted wages in the period also advanced the most in three years while lending has jumped at a rate of more than 20% in the past 10 months. Latest economic data „slightly emphasize upside risks, however some of these risks can change very quickly,” Niedermayer said. The „figures coming from the economy are somewhat stronger than we expected,” however „the interest- rate setting should reflect the fact that we have significantly undershot” the target.

Industrial producer prices grew 3.2% in February from a year ago, the most in almost two years. The spillover of rising costs to consumer inflation has been limited, thanks to high competition and the economy's openness, Niedermayer said. Also, the inflation data don't signal price growth stemming from consumer demand, according to the banker. „I admit the possibility that demand-driven inflationary pressures won't be substantial in spite of all we can see -strong economic growth, a continued lending boom, etc.,” he said. (Bloomberg)