Guvernér Rusnok – V ČR stále převládá nezájem o přijetí eura

Interview of the CNB Governor Jiří Rusnok
By Sándor Pető (Világgazdaság 9. 3. 2022)

The war in Ukraine has created a whole range of unknowns - said Jiří Rusnok, Governor of the Czech National Bank (CNB) in an interview to Világgazdaság. Czech interest rates are now close to the peak, but may stay high longer than initially expected.

Mr. Governor, does the Russia-Ukraine conflict pose any risks to CEE economies in your view? Can the developments there influence your decisions in any way?

We monitor all relevant events in society that may affect us. This conflict will certainly affect our part of Europe, not only in the short term, but most probably in the medium term as well. There are a whole range of unknowns. It is certainly complicating the return of our monetary policy to normal. No sooner have we found our way out of Covid than war breaks out in Europe. It will probably create inflationary pressure and perhaps also put downward pressure on economic growth. However, we must wait for more accurate estimates of the impacts.

Relative real interest rates, that is interest rates compared to inflation, have become a main issue globally, and also in the region. Is that a major factor in your thinking as well?

The CNB has been operating under inflation targeting since 1998. Until 2020, we managed to keep growth in the price level close to our inflation target, i.e. around 2%, on average. We used interest rates as our sole instrument (except for the exchange rate commitment between November 2013 and April 2017). In this sense, my answer to your question is yes.

Is the Fed too hawkish and the ECB too dovish in your view? Does inflation have more favourable dynamics in Europe than in the U. S.? How will the Fed and the ECB proceed with interest rate policy in your view in the next year or years? Do Czech central bankers watch their hands?

The Czech economy is a small, extremely open economy. The entire economic environment is relevant to us and we consider it thoroughly in our analyses and forecasts. At the same time, as the national monetary authority we primarily look at domestic indicators. It is not for me to judge the appropriateness of the monetary policy stance in other jurisdictions. However, I think other central banks will also start to gradually tighten the still extremely easy monetary conditions, especially given the persisting inflation pressures and the risk of them gradually becoming anchored in rising inflation expectations.

Looking at relative interest rates more locally, do you see a race in monetary policy tightening in Central Europe?

I certainly see no race to tighten in the CEE region. Each central bank is reacting according to its specific conditions, which are based on the fundamental evolution of macroeconomic indicators and the legal and institutional environment in each country. We are also experiencing a new phenomenon of inflation pressures being almost global in a single period of time. This is causing many central banks to respond in a similar way.

Do you expect real interest rates arrive to the same approximate levels in the region this year? Do you have a projection for that level, or at least the Czech nominal and real interest rate?

I don’t know whether interest rates in the region will become aligned at roughly the same level. It may happen, but not necessarily. Basically, it’s not very important.

At what level do you think the main CNB interest rate will peak? What is your feeling, when can you start to cut rates again? Earlier perhaps than others in the region?

I think we are now close to the peak, but a further slight increase in rates still cannot be ruled out. Future changes in CNB rates will depend strictly on new data and on our assessment of it. I fear rates will stay higher rather longer than we initially thought, due among other things to the escalation of geopolitical tensions in Europe and related complications, especially in the area of energy commodities.

Taking another approach: among the region's main economies, the Czech Republic has the highest inflation at the moment. Will that change in your view along the year? Are there common factors behind inflation in CEE countries, or idiosyncratic causes which may lead to a divergence this year or later?

There are several reasons why the Czech Republic currently has the highest inflation rate in the region. The first, and in my opinion also the most important, is methodological. Unlike in other countries, our CPI index includes the cost of owner-occupied housing (imputed rent), and its weight is relatively large at more than 12 percent. Looking at the most recent figure – the annual inflation of 9.9 percent in January 2022 – we can see that this item alone is responsible for almost 2 percentage points. For example, the Harmonised Index of Consumer Prices (HICP) used in the euro area and the EU as a whole does not contain this item at all.

Additionally, the previous government decided not to levy VAT on energy – gas and electricity – in November and December 2021. This led to an apparent drop in inflation in those months and conversely to a sharp increase in January 2022, when this relief was no longer in place. At the same time, the Czech Republic has long had the lowest unemployment rate in the entire EU. The number of vacancies has long exceeded the number of job applicants. Wage growth was markedly higher than growth in labour productivity in 2015–2021. Furthermore, growth in property prices in the Czech Republic has been well above average in recent years.

All this is contributing to the strong inflation pressures. However, if we correct for differences in measurement methods, I dare say Czech inflation is not fundamentally different from that in neighbouring countries.

Do you expect a further rise in demand in the region and the Czech Republic as the pandemic fades? We have already seen an economic slowdown in parts of the region, do you think a rise in interest rates contributed to that? Will not tight monetary policy kill growth? Do you expect the government to also take measures to fight inflation, like other governments in the region did? Are the CNB's own measures effective to cut inflation, given the continuing rise?

Our current estimate of real GDP growth in the Czech Republic this year is 3 percent. We thus expect very moderate growth in demand and a gradual return of economic output to the pre-pandemic level in the course of 2022. In this respect, the Czech Republic is lagging behind its V4 neighbours and also behind the EU average. This is due mainly to the structure of the economy. The Czech Republic has an above-average share of the automotive industry, which, as you know, is not going through the best of times, mainly on account of disruptions to component supplies and the structural transition to electric cars. The drastic rise in energy prices will result in a decrease in consumer demand for other goods and services (our estimate for the Czech Republic is 2–3%), which will further weaken demand. However, we still expect real GDP to rise by around 3 percent, i.e. roughly at the Czech economy’s current potential growth rate. Therefore, monetary policy alone will certainly not kill our economic growth.

The Czech government has decided so far not to make direct interventions in retail prices like those seen in the other V4 countries (for instance the VAT decrease in Poland and the fixing of some prices in Hungary and Slovakia). I personally think this is the right approach. It is more painful, but it could contribute to a faster end to the inflation wave, and it will also place a lower burden on public finances.

The crown has strengthened a lot since last year, helped by the CNB's tightening. Is not it already too strong for the economy? Can you see a level beyond which it should not go? In the past, Czechia even had a formal fx rate threshold, is there a chance that you will have one again?

The strengthening koruna is helping to cool the inflation pressures. Until 24 February, this was in line with the significant positive interest rate differential against the euro and the US dollar. Unfortunately, what happened in Ukraine put an end to this trend and pulled the koruna back. On Friday 4 March we announced the start of foreign exchange market interventions to dampen excessive exchange rate fluctuations and the weakening of the koruna. As a result of the geopolitical tensions, we thus certainly need not fear an excessively strong koruna damaging the Czech economy in the coming period.

The last question is about the euro: do you see a chance or need for Czechia to set up an accession target date in the foreseeable future? If you had the euro right now instead of the crown, would Czechia be better off? Ten years from now, can I still pay for my beer in downtown Brno in crowns, or I will need euros?

Nothing substantial has changed in this area over the last ten years. The population, and above all the political scene, in the Czech Republic remain largely uninterested in EMU accession. People’s confidence in the koruna is high. The CNB is a successful inflation targeter. If we had the euro today, we would probably be faring similarly as we are now (see the case of Slovakia). So, I think we will still be paying in Czech korunas in Czech pubs ten years from now.

(We sent our questions to Mr. Rusnok before the Russian-Ukrainian war started, the replies arrived on 7 March 2022.)