Europe's Hawkish Turn Is Led by First Czech Rate Hike Since 2008

(Bloomberg) -- The Czech central bank is teeing up more increases in interest rates after starting monetary tightening in Europe with its first hike in almost a decade.

The koruna jumped the most in three months after the benchmark rate was raised to 0.25 percent from a record-low 0.05 percent in a unanimous decision on Thursday. While revised staff forecasts show much stronger economic growth this year and next, Governor Jiri Rusnok told reporters he couldn’t give clearer guidance for policy tightening other than saying that more hikes probably loom over the next two years.

“Unlike the euro zone, we’re experiencing a very real, visible and robust wage growth, and given the record employment levels, the volume of wages is expanding even faster,” Rusnok said at a news conference in Prague after the decision. “That represents a huge cash injection that largely goes into consumption, which is the driver pushing the Czech economy ahead.”

Rate setters are dusting off their conventional toolbox after exploring the extremes of monetary policy with a Swiss-style currency cap on koruna appreciation that was imposed in 2013 and scrapped in April. While their peers in the region and the euro area are still waiting for more evidence that price growth is robust enough to warrant tightening, the Czech central bank sees inflation near its 2 percent target through 2018 as the economy outperforms its earlier outlook.

It’s “the start of a gradual tightening cycle,” said Liam Carson, an analyst covering emerging Europe at Capital Economics Ltd. in London. “There is a growing chance that we could see another rate hike before the end of 2017.”

The rate increase sent the koruna rallying as much as 0.8 percent to the strongest since 2013. It pared gains and traded up 0.3 percent at 26.015 against the euro as of 3:20 p.m. in Prague. The exchange rate has appreciated 4 percent since the end of the intervention regime, the best performance among 31 major currencies tracked by Bloomberg worldwide.

“The koruna has been appreciating at a pace that gives us no cause for concern,” Rusnok said, adding that the bank’s baseline scenario is for continued “moderate” appreciation. “We are convinced that it is adequate to what the Czech economy needs at the moment.”

With headline inflation running above the target for most of this year, rate setters are focusing on underlying price pressures stemming from accelerating wage growth and the European Union’s lowest unemployment.

Gross domestic product will add 3.6 percent this year under the central bank’s updated outlook, up from its previous forecast for a gain of 2.9 percent. The annual consumer-price index will be at 1.9 percent in the third quarter of next year and end 2018 at 1.8 percent, downward revisions from its previous predictions for 2 percent and 1.9 percent, respectively.

Apart from curbing future inflation, the central bank is also trying to a avert a potential mortgage bubble after Czech home prices grew at the fastest pace in the EU for two quarters. Policy makers have repeatedly said they prefer to tackle the housing-market risks through tighter capital requirements and lending standards, but mentioned rate hikes as a possible tool as well.

“Increasing the policy rate shouldn’t lead to a major slowdown in the economy because monetary policy will remain accommodating and the Czech National Bank’s moves will only be gradual,” said Natalia Kornela Setlak, an analyst at Nordea Markets. “The interest-rate increase should, nevertheless, lead to a slight decline in currently observed price pressures, which will also be negatively affected by the sharp koruna appreciation.”

--With assistance from Andre Tartar Zoya Shilova and Marton Eder

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net, Krystof Chamonikolas in Prague at kchamonikola@bloomberg.net.

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net, Paul Abelsky, Andrea Dudik