East EU's Inflation Remains Benign as Policy Paths Diverge

(Bloomberg) -- Czech consumer prices grew much less in March than the central bank expected, deepening a dilemma for rate setters who’ve pledged to continue tightening policy but differ on how quickly interest rates need to rise.

The annual inflation rate declined for a fifth month, to 1.7 percent, moving further below the central bank’s target and missing its 2.3 percent forecast. Fellow eastern European Union member Hungary reported a slight acceleration in inflation to 2 percent, which returned price growth to within the target range but still left it way off the central bank’s 3 percent goal.

The central banks in Prague and Budapest are in different phases of monetary cycles even if both nations are enjoying accelerating economic growth and declining unemployment rates. The Czechs were the first in Europe to raise borrowing costs last year and outlined more tightening for the next 12 to 18 months. By contrast, Hungarian rate setters are deploying unconventional tools to keep market rates low and support economic activity.

While rapid wage increases -- fueled by EU’s lowest unemployment rate -- failed to prevent inflation slowdown, the Czech central bank isn’t “overestimating” the importance of the trend and sees consumer price growth returning toward the 2 percent target in coming quarters, Governor Jiri Rusnok said after the data were published.

“We’re supposed to continue to go this way next quarters, next few years at least,” the governor said at a conference, referring to the forecast implying the next rate hike near the end of the year or early in 2019. “Of course, it is very much also dependent on what will happen in the euro area.”

Read more: Czechs Revert to Rate Cruising Mode After Leading EU Hikes

Czech policy makers kept borrowing costs unchanged last month, after discussing both arguments in favor of faster rate increases and reasons for a more measured approach. Some rate setters saw inflation slowdown as temporary and caused by volatile food prices. Others argued that it could be the result of more fundamental changes in the economy.

Czech has inflation has probably bottomed out now, according to Jiri Polansky, an analyst at Ceska Sporitelna AS in Prague, who forecasts the next Czech rate hike in the fourth quarter.

“Inflation pressures caused by wage increases are mitigated by large investment amounts that are boosting productivity," Polansky said. "So the monetary policy settings will be primary influenced by developments in these two factors.”

The Hungarian central bank also held interest rates steady in March, pledging to continue with a policy of intervening in the market designed to cut long-term borrowing costs and keep short-term rates near zero.

Despite the slight acceleration last month, Hungarian price growth remained well below the goal and it may “hover at the lower end of the target range for the rest of 2018,” Dan Bucsa, the chief CEE economist at UniCredit, said in an emailed note before the data was published.

--With assistance from Krystof Chamonikolas

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net, Marton Eder in Budapest at meder4@bloomberg.net.

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

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