Czechia: Inflation risks are intensifying

The Czech economy continues to perform well and has demonstrated notable resilience to global headwinds. GDP growth is likely to slightly exceed 2% this year and accelerate further next year. Economic activity will continue to be driven primarily by household consumption, with fiscal expansion providing additional support. Labour market conditions remain favourable, with the unemployment rate likely close to its non-inflationary equilibrium level. Wage growth remains strong and continues to generate inflationary pressures; however, the recent revision of first-quarter wage growth from around 8% to 6% suggests a somewhat less inflationary outlook than previously assumed.

Although inflation remains relatively low, with August figure at 1.9%, inflation risks are beginning to build in the background. Alongside strong household demand and expected fiscal expansion, the main source of concern is the recent increase in energy prices, including fuel costs. A further area of significant uncertainty is food price developments, where the expected reversal of recent trends is likely to be compounded by the effects of severe drought and higher commodity prices. As a result, food prices could surprise significantly to the upside at the beginning of next year. We currently expect inflation to peak at 3.4% in February. However, a simultaneous materialisation of these supply-side risks could push inflation into the 4-5% range. At this stage, we view such an outcome as an alternative scenario rather than our baseline forecast. We continue to expect one additional CNB rate hike later this year. Should the upside inflation scenario materialise, however, the CNB could ultimately raise rates by a further 25-50bp beyond our current baseline. The koruna remains broadly in line with its fundamentals, and we do not anticipate any significant movements in the exchange rate.

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