Czech Central Bank Keeps Interest Rates on Hold

The Czech koruna fell against the euro today following the decision by the Czech central bank to keep what are till the European Union's lowest interest rate on hold to try to restrict the ongoing rise in the currency. This is a very tricky game to play indeed, and the bank effectively bucked the trend among other the other EU10 central banks who have some sort of autonomy left over their monetary policy (Romania raised rates today, as did Poland, while we could say that in Slovakia - where they have incraesingly less monetary policy options left by the day as they make one last desperate effort to converge with the eurozone despite a sudden acceleration in inflation and GDP growth - the decision not to raise was effectively taken for them, since they cannot afford to enter EMS with an excessively high partity rate with the euro).

The Prague-based bank left the repurchase rate where it was,at 3.75 percent. The koruna has gained 8 percent against the euro in the past six months alone, ranking it as the world's best performer during the period of global financial turmoil.

The Czech currency fell as much as 0.8 percent following the news, down to 25.662 per euro and was at 25.502 by 5:22 p.m. in Prague, from 25.471 yesterday. It has now fallen 1.8 percent since the central bank said March 18 it will freeze the proceeds from state-asset sales.

Policy makers want to revive a 2002 accord whereby foreign- currency proceeds from the sales would be put in a special account to keep fund flows out of the market and limit demand for the koruna, Deputy Governor Mojmir Hampl said. Policy makers are concerned more rate increases, after eight in the past two and a half years, would push the koruna even higher, threatening to become completely counter productive.

``The bank board has consensually agreed that the decision- making is uneasy and risks of leaving the current rate trajectory are relatively high,'' central bank Deputy Governor Miroslav Singer said today. ``We perceive the situation as burdened with balanced but substantial risks in both directions.''

Czech Retail Sales January 2008

Czech retail sales grew at the slowest annual rate in four months in January as accelerating inflation curbed shoppers' purchasing power, supporting speculation that interest-rate increases may not continue. Sales rose 4.1 percent, compared with an annual increase of 5.4 percent in December, the Czech Statistical Office said today.




Retail sales, excluding cars and motor fuels, were up by 3.3 percent and were 4.9 percent higher when seasonally adjusted, led by clothing, furniture and electronics. Sales of cars and motor fuels grew 6 percent.

Consumer spending has eased back as inflation accelerated to 7.5 percent in January from 1.3 percent a year earlier. The central bank expects cooling household spending, the main driver of economic growth in the past two years, to restrain the Czech expansion back to a 4.1 percent GDP growth in 2008 from 6.5 percent 2007. If today's data give them some encouragement to believe they are succeeding then they may well leave the main interest rate at its current 3.75 percent. Certainly with an average inflation rate this year of over 6 percent and nominal wage increases of around 8 percent, real salaries may well increase by less than 2 percent following the 4.4 percent increase in real wages in 2007. So this would definitely be a move in the right direction if it can be sustained.

The koruna fell to 25.208 per euro by 10:47 a.m. in Prague, compared with 25.141 yesterday. The ask yield on the government benchmark bond maturing in 2018 rose 5 basis points to 4.59 percent.

Czech Producer Prices February 2008

According to the latest release from the Czech Statistics Office prices of agricultural and industrial producers were up in February by 0.7% and 0.1%, respectively over January, while prices of construction work and market services grew by 0.4% and 1.1%, respectively.

In comparison to February 2007, prices of agricultural and industrial producers increased by 27.1% and 5.6%, respectively; prices of construction work and market services were up by 4.5% and 3.4%, respectively. That is core industrial producer prices are now rising at a 5.6% annual rate.




Agricultural producer prices grew by 0.7% in total. Prices of crop products rose by 2.0% due to higher prices of cereals (+3.4%). Prices of potatoes, fruit and vegetables fell by 5.8%, 2.3% and 1.7%, respectively. Prices of animal products fell by 1.0%; lower were prices of milk (-0.2%), poultry (-1.6%) and pigs for slaughter (-3.6%). Higher prices were recorded for eggs (+0.9%).

Industrial producer prices rose by 0.1% (+1.9% in January). The growth of price level came mainly from higher prices in ‘basic metals and fabricated metal products’ (+0.6%), ‘machinery and equipment” (+0.9%) and “chemicals, chemical products and man-made fibres’ (+1.1%). Prices increased in 'food products, beverages and tobacco’ by 0.2%, of which the most marked increase was recorded for ‘animal and vegetable oil and fats’ by 6.7% and ‘prepared animal feed’ by 2.4%. On the other hand, prices dropped in ‘meat and meat products’ by 1.6% and ‘dairy products and ice cream’ by 1.4%. Prices decreased in ‘transport equipment’ by 0.9%, ‘coke, refined petroleum products' by 0.8% and in ‘rubber and plastic products’ by 0.6%.

Construction work prices rose by 0.4%, and so did prices of construction material input (+0.6%).

At the same time export prices decreased by 2.6% in January (following a 2.1% decrease in December) dropping for the third month in a row. The underlying reason for this improved performance is undoubtedly the appreciation of the koruna. The biggest price decreases were registered in ‘miscellaneous manufactured articles’ which were down by 5.2% (particularly articles of apparel and clothing accessories), ‘machinery and transport equipment’ down by 4.9% (especially general industrial machinery and equipment) and ‘chemicals and related products’ down by 3.8%. In contrast, the highest price increases were recorded for ‘food and live animals’ - up by 12.7% (mainly cereals and cereal preparations) - and ‘mineral fuels, lubricants and related materials’ - up by 18.0% (particularly coal, coke and briquettes and electric current).

Czech Inflation and Unemployment February 2008

Czech consumer prices rose by 0.3 percent in February, keeping annual inflation at the nine-year high of 7.5% which it reached in January, the statistical bureau said on today. Price growth was driven mainly by housing prices, including water and heating, and kept open the possibility that the central bank will raise interest rates once more in the next few months. A separate set of figures from the Labour Ministry showed unemployment fell to 5.9 percent in February from 6.1 percent in the previous month.




The data lacked the kind of negative surprise impact which shocked the market in January but this continuing high inflation may well prompt more monetary policy tightening. The central bank has raised the main repo rate by 200 basis points to 3.75 percent as the economy grwon at a tidy clip over the past three years.

The central bank has acknowledged inflation is still 0.6 percentage points above its fresh forecast, and has been struggling to try to anchor inflation expectations, suggesting that the current spike is largely a short-term deviation.


A major anti-inflationary factor has been the rise in the value of the koruna, which currently stands up some 11 percent year-on-year against the euro. It has been cooling off from the record 24.83 seen on March 4, and briefly dipped to 25.125 after the inflation data from 25.095 before but then firmed back to 25.033 by 1310 GMT.

There are various risks to the banks inflation forecast on both the supply and demand sides. One clear danger if that the rapid rise in some prices, even if only temporary, creates higher costs for businesses that may lead to rises in other prices as well as higher expectations for higher inflation among Czech consumers and companies. This risk may well prompt the Czech central bank to raise rates either this month or in the not too distant future.

On the supply side there are gowing pressures from labour shortages in some sectors. Separate unemployment data out today from the Ministry of Labour and Social Affairs showed the number of jobless fell to 5.9%, its third lowest level since 1998 in what is already tight labour market, further boosting the case for a rate hike.

In February the Czech employment offices registered a total of 355,033 job seekers. That is 9,511 less than at the end of January, and 99,704 less than in February 2007. The number of available job seekers (job seekers currently available for work) was 330,641. In the course of February, job offices registered a total of 40,002 first signings. That is 23,152 job seekers less than in January and 718 newly registered job seekers less than in February 2007. In February job offices registration was terminated by 49,513 job seekers. New jobs have been taken up by 31,735 persons.


In February 2008 the unemployment rate was 5.9 % (January 2008: 6.1 %, February 2007: 7.7 %). The unemployment rate was higher than average in 35 districts, the highest being in Most (14.9 %), Karviná (13.1 %), Znojmo and Jeseník both (11.9 %) and Teplice (11.8 %). The lowest unemployment rate was in the districts of Praha–východ (1.7 %), Praha–západ (1.9 %), Praha and Mladá Boleslav (both 2.2 %). The unemployment rate for women was 7.2 % and the unemployment rate for men was 5.0 %.

Czech Wages and Salaries Q4 2007

Czech real wage growth slowed the most in two years in the last quarter of 2007 as inflation accelerated. The average monthly paycheck rose 1.9 percent when adjusted for inflation, compared with growth of a revised 4.9 percent for the preceding three-month period, the Prague-based statistical office said today. The average gross monthly salary advanced 6.8 percent to 23,435 koruna ($1,435). For whole year 2007, real wages advanced 4.4 percent, the most in four years.



The average inflation rate rose to 4.8 percent in the fourth quarter from 2.5 percent in the third, eliminating most of the nominal wage increase negotiated by unions and their employers. Policy makers at the central bank have said the inflation surge is only temporary and have urged against any reopening of wage talks in an attempt to prevent the inflation rate from rising.



In the private sector the monthly paycheck was 6.7 percent higher at 23,484 koruna. When adjusted for price growth in during the year, wages grew 1.8 percent, the office said.

State-employee salaries grew 7.1 percent in October through December from a year earlier to 23,259 koruna, translating into a 2.2 percent real advance.

The central bank indicated last month it may begin to bring down what are still the European Union's lowest rates as early as later this year, citing the strong koruna, faltering economic growth and the fading effect of cost and administrative shocks on inflation.

At the same time, policy makers have said they are ready to resume lifting borrowing costs to prevent inflation and a scarce labor force from sparking excessive wage growth.

Offering us one possible indicator of what may be to come Toyota Peugeot Citroen Automobile, a Czech car venture formed by automakers Toyota Motor Corp. and PSA Peugeot Citroen, have said this week that wages will increase by 7 percent with effect from from April 1.

Czech January Trade Surplus

The Czech Republic posted a substantial January trade surplus following on the back of very healthy export growth, suggesting that manufacturers are still managing to weather the effect of the koruna's eight-month rally.




The 12.2 billion koruna ($748 million) surplus followed a revised 3.3 billion-koruna gap in December and a 9.8 billion- koruna positive balance in January 2007.

The koruna has advanced 15 percent against the euro since July, making it the world's best performer over the last half year. The strong currency puts pressure on exporters' revenue or makes their goods less competitive. The German economy, which is the destination for one-third of Czech exports, is expected to slow in 2008, with economic growth being forecast by the German government to reduce to 1.6 percent from 2.5 percent in 2007.

Exports in January rose 11 percent year on year and advanced to 210.1 billion koruna while imports amounted to 197.9 billion koruna, up 10.3 percent from a year ago.




The Czech Republic's 2007 trade surplus totaled a revised record 85 billion koruna, a third straight full-year surplus.

Czech GDP Q4 2007 Detailed Report

The Czech economy grew in the fourth quarter of 2007 at the fastest pace in almost two years on increased demand for health care and higher public spending on construction works according to the final report from the statistics office which is out today. Gross domestic product expanded year on year by 6.6 percent, which compares with the preliminary estimate of 6.9 percent reported on Feb. 15 and a revised 6.3 percent for the third quarter.



The economy grew by a record 6.5 percent in whole year 2007.



The government raised indirect taxes and imposed fees to discourage people from overusing public health care. That triggered higher spending on items such as drugs in late 2007, more than outweighing the effect of surging inflation on household expenses. This year's growth will slacken to between 4 percent and 5 percent, according to the official forecast.

The central bank predicts GDP will grow 4.1 percent in 2008 and the inflation rate is projected to pick up to 6.3 percent from 2.8 percent.

Consumer spending, which was the dominant driver growth for a consecutive second year, rose by 4 percent in constant price terms in Q4 when compared with Q4 2007, the slowest pace in two years. On the other hand, government expenditure was up 3.1 percent in the October- December period, the first increase in real spending in three quarters.

One-time factors ``predominantly applied to increased performance of the health industry, which resulted in higher expenditures of health insurance companies, and more intensive repair of road network with the impact on final government consumption expenditures,'' the office said. Without these effects they estimated growth would have been around 6 percent.

Gross fixed investment growth accelerated to an annual 8 percent in real terms and 9.8 percent in nominal ones, adding 2 percent to the overall GDP growth.

Exports of goods and services climbed at an annual rate of 12.5 percent when adjusted for price growth, more than a 10.2 percent increase in imports, as Czech manufacturers continued to benefit from rising demand in other EU nations, and in particular in Germany and Slovakia. External trade accounted for 2 percent of the GDP increase.

Czech GDP Q4 2007

The Czech Republic's economy unexpectedly expanded accelerated in the last quarter of 2007, graowing at the fastest pace in two years, fueled by investment, solid exports and rising employment. Gross domestic product grew at a 7.0 percent annual rate on a seasonally and working day adjusted basis (preliminary data), compared with a revised 6.4 percent in the third quarter, the Czech Statistical Office said today. The Office also announced that the economy grew 6.6 percent in 2007.

The quarterly rate of expansion accelerated from the 1.4% achieved in the third quarter to a full 1.9% in Q4.However it should be noted that the statistics office single out expenditure by health insurance companies, which are classified as part of the general government sector, as contributing to the GDP increase by approximately 0.5 percentage points (ie a good part, if not all, of the acceleration). They suggest that this is probably due to higher demand for health services which remained free till the end of the year and in anticipation of the introduction of medical fees for certain services in 2008. So much of this may well be "one off".



Following the news the koruna had its biggest weekly gain in 5 1/2 years - rising for a fourth succesive week - and at one point was up by as much as 0.7 percent on the day (at 25.080, its highest level ever against the euro), before closing at 25.193 by 4 p.m. in Prague. In the last week it has advanced by 2.4 percent, the fastest rate since June 2002. So far this year the koruna has been the best-performing of the nine European emerging-market currencies, gaining 5.5 percent against the euro.



Household consumption has bolstered the Czech economy's expansion for almost two years now, and is driven by accelerating wage growth, a 30% y-o-y rate of increase in lending and a decade-low jobless rate. The very low number of people now remaining unemployed has given rise to concerns that if the economy should continue to grow as quickly as it is doing currently, then wage-cost driven inflation may get the economy in its grip in the way it has done in other EU10 economies. The average nominal hourly wage in industry rose by 11.3% in December 2007 over December 2006, while the average monthly nominal wage in industry rose by 7.4% in 2007 when compared with 2006.



The extra growth is certainly creating employment, and there were 1.9 percent more people working in the economy during the last quarter of 2007 than there were one year earlier. Still, the statistics office (although it gave no details, for thpse we will have to wait till March) stated that household spending growth slowed in the fourth quarter (retail sales, for which we do now have December figures, rose only at an annual rate of 4.3%), dropping back from the 5.6 percent rate of increase of the previous three months, discouraged perhaps by the 4.4 percent inflation rate experienced over the period.



This change in the structure of Czech GDP growth, with consumer demand accounting for a smaller portion of expansion, and exports and capital investment accounting for more, is fueling central bank optimism that the inflation rate can gradually be clawed back to the mid-point 3 percent target by next year, from the whopping 7.5 percent registered in January.



The bank predicts GDP will grow 4.1 percent this year after an estimated 6.1 percent in 2007, thus being a touch more skeptical than the Finance Ministry who are currently advancing a 4.7 percent growth outlook for this year.



Long Term Structural Problems On The Fiscal Side


There is however still plenty of room for concern about the medium term evolution of the Czech economy. Only last week the European Union reiterated its call for the Czech government to address underlying fiscal pressures linked to the pace of population ageing in the Republic, and stressed that the administration needed to do more to prevent the creation of excessive budget surpluses. The call was made as part of the EU Commission periodic assessment of individual country convergence programmes.

The Czech Republic is by no means the oldest of the EU10 societies, indeed at around 40 the Czech median age is not especially high at this point (even by EU10 standards) - and Slovenia and Bulgaria have higher median ages.

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But life expectancy in the Czech Republic is significantly higher than the rest of the group (coming second in this respect only to Slovenia) and hence the weight of pensions expenditure is likely to be greater than in many other states in the region.



As a result of this higher than average EU10 life expectancy, and many years of lowest-low fertility, the Czech population median age is set to rise very rapidly - to around 44 in 2020 - which means that the Czech Republic will soon be older than several West European societies (where there has been higher fertility and more substantial immigration) like France or the UK. And this despite the fact that the Czech Republic has been one of the few EU10 societies to be really proactive on the immigration front in recent years.




The Czech Republic's budget deficit is now within the EU 3 percent of GDP limit, but this is not the Commission's real concern in this report. Rather what are being raised are longer term structural and sustainability questions. The Czech government should "exploit the likely better-than- expected 2007 budgetary outcome to bring the 2008 deficit below the 3 percent of GDP reference value by a larger margin" the EU said in the report since "The Czech Republic remains at high risk with respect to the sustainability of public finances".

Essentially the EU is criticising the Czech Republic for failing to take advantage of the record economic growth to cut spending, overhaul the pension and health-care systems and reduce the deficit so it may be used as a stabilising cushion in the event of an economic slowdown. The Czech Cabinet has responded to the ongoing criticism from the Commission by amending the tax code, cutting welfare spending and imposing health-care fees. But the Commission is far from satisfied, and in particular they have said the following:

The Czech Republic appears to be at high risk with regard to the sustainability of public finances. The initial budgetary position in the programme is not sufficiently high to stabilize the debt ratio over the long-term. The long-term budgetary impact of ageing is well above the EU average, influenced notably by a substantial increase in pension expenditure as a share of GDP as well as a significant increase in health care expenditure. Implementation of structural reform measures notably in the field of pensions and health care aimed at containing the significant increase in age-related expenditures would contribute to reducing risks to the sustainability of public finances. While initial steps have been made to reform the health care system, reform of the pension system still lacks implementation against a definite timetable.

To date the Czech Cabinet has pledged to trim the public deficit to 2.6 percent of GDP in 2009 and to 2.3 percent in 2010, but given the rate of GDP increase, and the rapid rise in the koruna, a strong move in the direction of a budget surplus would seem to be called for.

The Czech administration, which in 2006 abandoned 2010 as the country's euro-adoption date, has pledged to overhaul the welfare, pension and health-care systems in an attempt to ensure that country is in a position to fulfill the EU fiscal rules after it accepts the common currency. One of the problems being faced is that the ruling coalition lacks a sound majority in the Czech Parliament, and has to rely on two former opposition deputies, which makes progress on serious reform an uphill struggle.

But if it remains substantially unamended, the current pensions system will weigh heavily on state finance during the coming years due to the rapidly increasing number of retired people and the shrinking number of potential contributors. The working age population - 15 to 64 - is set to shrink from around 7.25 million now to around 6.4 million in 2025.



While the elderly dependent population - defined as being over 65 - is set to rise from around 1.5 million currently, to around 2.25 million in 2025.



Now the numbers involved here are not excessively large, and the situation can to some extent be eased by immigration, raising participation rates, and raising the retiremnt age beyond 65. But it is important to note that all the countries in the region are facing - to a greater or a lesser extent - the same problem, so it isn't clear where the migrants are to come from, and if they ultimately will arrive from another continent, then this has implications for the cultural model on which these societies have been based to date. Which is not to say that such an outcome is unattainable, but simply that it is not going to be as easy in practice as it perhaps appears to be on paper.

On the pensions side the current problems are threefold: i) the excessive reliance on a PAYGO system, ii) the high level of contrubutions, iii) the low level of the retirement ages. Pension contributions currently total around 30% of employee earnings, of which 7.5 percentage points are paid by employees and 22.5 points by employers. These contribution levels are among the highest in the OECD, and only Hungary, Italy and Slovakia have higher contribution rates.

Following an earlier reform, the retirement age is gradually being increased from 60 to 63 years for men and from a range between 53-57 years to one between 59-63 for women (with the retirement age depending on the number of children they have had) between now and 2013. But such age increases are clearly far from sufficient. As a result the Czech cabinet agreed last Monday to raise the retirement age and lay the basis for wider pension reforms to secure the system's long-term financial stability.

The cabinet sent a bill to parliament which envisages a gradual increase in the retirement age to 65 by 2030 and an extension of the required length of employment. A further proposed step will follow later which involves moving from the current pay-as-you-go scheme to a partially fund-based system where people save for their own pensions. Czech pension payments are expected to reach 306 billion crowns ($17.34 billion) this year, taking up nearly 30 percent of the national budget, and will grow rapidly as the population ages if nothing is done.


Basically the big problem with moving from PAYGO to partially funded schemes is maintaining the payments from the PAYGO system during the transition. As a way of trying to get round this problem the government proposes to set up a fund fed by income from privatisations, with the idea being that the shortfall caused in the old system by the payment diversion into would be made up from the reserve fund. Many Czechs already have private pensions savings, which are supported by government subsidies and tax breaks, but the volume is too low to support them in retirement. The average Czech state pension is 9,111 crowns ($515.9) per month, about 42 percent of the average salary.


Bad Timing or Bad Decisions?

So much for the longer term issues, but the real danger facing the Czech economy at the present time is that a number of faulty short-term decisions, and a certain tardiness in reform coupled with an unhelpful external environment, may well cost the Czech Republic dear in the longer term.

In the first place the recent decision to raise administered prices in January has produced a sharp 2% hike in the annual inflation rate (from 5.4% in December to 7.5%in January). In particular the government raised value-added tax on basic items such as food to 9 percent (up from 5 percent), and introduced a 30 koruna ($1.71) fee for doctor's visits. In total the health service increases added 0.5% to the annual inflation rate. The price of electricity also went up 9.5 percent and natural gas 7.8 percent. State-controlled rents jumped 18.9 percent from their December level.

So the danger is that the application of such measures in an environment where growth is strong, and possibly even above capacity, and the labour market is extremely tight, may simply lead to an ongoing process of second round effects, where wage rises to compenate for inflation (or over and above the inflation rate) simply add more fuel to the underlying inflation dynamic. In order to try and avoid this outcome the central bank will undoubtedly continue raising interest rates. The bank has already raise rates five times since last June - at quarter point intervals (with the last raise being on the 8 February - and the current rate is at 3.75%. The prospect of the bank doing just this, coupled with the comparatively high rate of GDP growth, is already pushing - as we have seen above - the koruna ever onward and upward. If, as now seems likely, the Czech base interest rate should pass an ECB refi rate which was on the way down as the eurozone economy slows, then this upward pressure on the koruna might well accelerate, and the central banks attempts to restrain inflation with conventional monetary policy might well prove thwarted.



Added to this problem of inflation and a rising koruna, is the associated one of the evolution of the Czech trade balance. While the Czech Republic has so far enjoyed a fairly healthy goods trade surplus, this does not come by divine fiat, and changes in relative prices can erode the situation quite rapidly. Exports in December were up 5.2 percent year on year down down substantially from the 20 percent rate in November and the smallest figure in the whole of 2007. For the time being this is simply a seasonal blip, but the whole Czech external trade situation will now need monitoring carefully, and in particular given that the German economy now seems to be slowing, and the Czech economy is inter-locked with Germany (31% of the CRs exports went to Germany in 2007) to a very high degree.



In this context the position of the fiscal deficit of the Czech administration takes on even more importance. As indicated above, the Czech Republic's budget deficit is certainly likely to fall with the EU limit of 3 percent of gross domestic product this year, although the deficit may in fact widen to 2.95 percent of GDP from an estimated 1.9 percent in 2007. The original goal for 2007 was 4 percent of GDP, so the outcome is, in terms of the EU convergence process, not especially bad. But in terms of the current short and medium term macro environment, the projected level of deficit is certainly fraught with risk. Ideally the objective for 2008 should be a budget surplus. This would act as a brake on excessive growth as the koruna rises (since capital funds into the CR in search of yield will definitely increase in the short term) and both the surplus and the newly higher interest rates would provide something of a cushion should further deterioration in the external environment (and especially in Germany) lead the Czech economy to start to slow too rapidly. However, as noted above, the extent of the danger does not seem to be appreciated, and we are still looking at a deficit in the 2 to 3% range. The risk that this may provoke excess inflation which will be hard to eradicate later is real and present, and hence the evolution of the Czech CPI will need to be monitored closely, especially given that January's large base effect is now built in for the whole of 2008. We can only realistically expect inflation to start to come seriously down as we get towards the autumn, and only then if.......

Czech Industrial Output December 2007

Czech industrial production slowed for a second consecutive month in December as faltering demand in western European countries and a rising koruna curbed Czech exports. Industrial production rose 2.9 percent, compared with an advance of 6.7 percent a month before, bringing the full-year increase to 8.2 percent, the Prague-based Czech Statistical Office said earlier today.



Economic growth in Germany, the No. 1 Czech trading partner, slowed to 0.3 percent in the fourth quarter from 0.7 percent in the third quarter. Expansion of industrial output, which is mostly destined for export, is expected to ease to about 5 percent this year, with the record-strong koruna, scarcity of workforce and rising salaries also contributing to the decline.

Czech December exports were up 5.2 percent on the year, the slowest pace since April 2006.

The average hourly wage jumped 11.3 percent in December. The number of people working in the industry grew 1.2 percent in the last month of 2007. Labour productivity increased 0.5 percent, compared with 5.5 percent in November.

Czech Current Account Deficit December 2007

The Czech monthly current-account deficit was the largest since last August in December as an increased number of foreign companies in the Czech Republic repatriated profits.

The monthly shortfall was 20.1 billion koruna ($1.14 billion), compared with a 1.2 billion-koruna deficit in November and a 13.2 billion-koruna gap a year ago, the Prague-based central bank said today.

The Czech current-account balance normally fluctuates according to when foreign investors collect locally earned dividends and profit, which are increasing rapidly as the Czech economy experiences economic growth of around 6 percent for a third consecutive year. With the full-year trade surplus having doubled, it is a good guess that the 2007 current-account deficit will have shrunk to something just under 3% of GDP - 2.8 percent perhaps.




The full-year current-account deficit reached 106.6 billion koruna.

The deficit on the income balance, which includes dividend payouts abroad as well as estimated reinvested earnings by foreigner investors, rose to 24.7 billion koruna in December and to 24.7 billion koruna for the whole of 2007.



The December goods trade surplus was reported as being 1.5 billion koruna, (this compares with a 1.1 billion-koruna surplus estimated by the statistics office last week). The surplus in services trade shrank to 3.7 billion koruna from 5 billion koruna in November, the central bank said.

The financial account for December 2007 showed a surplus of 7 billion koruna. The 12-month figure was 78 billion koruna, and failed to cover the cumulative current-account deficit. The country attracted net foreign direct investment of 18.1 billion koruna in December, a 60 percent increase over November. The central bank estimated reinvested profits at 10.8 billion koruna.

Czech Inflation January 2008

Czech consumer prices jumped a much faster than expected 3.0 percent month on month in January, pushed up to some considerable extent by government tax and health cost increases, putting strong pressure on the central bank to make further increases in a base interest rate that they only raised yesterday.

The Czech Statistical Bureau said on Friday the jump put year-on-year inflation at a nine-year high of 7.5 percent, sending the Koruna up to yet another new record high as currency traders started to bet on future rate rises. The market had expected a 1.9 percent monthly rise and a 6.2 percent annual price rise. The statistical bureau said nearly all of the January rise -- 2.9 percentage points -- could be attributed to the administrative measures.



The government raised value-added tax in January on basic items such as food to 9 percent from 5 percent, and also introduced a fee of 30 crowns ($1.71) for a doctor's visit. The price of electricity advanced 9.5 percent while natural gas was 7.8 percent more expensive. State-controlled rents jumped 18.9 percent from December, the authority said.

New health-care regulatory fees made up 0.5 percentage point to the overall monthly price index while food prices were 2.3 percent higher in the month, led by fruit, vegetables, meat and dairy products.

The inflation data followed a 25 basis point interest rate increase to 3.75 percent on Thursday, which still left rates well below the inflation rate.


The koruna rose to 25.668 per euro as of 1:15 p.m. in Prague from 25.715 before the data was released and from 25.756 in yesterday's late trading.

The ask yield on the government 10-year bond climbed 4 basis points to 4.48 percent. The price fell 0.3, or 30 koruna per 10,000 koruna ($565) face amount, to 100.95, according to Ceska Sporitelna prices. A basis point is 0.01 of a percentage point.

The central bank said in its quarterly forecast published yesterday that it expects inflation to reach 5.3 percent in the fourth quarter of 2008, before it falls to 2.4 percent in the second quarter of 2009 on anticipation that inflation will return to the target next year once temporary costs and administrative shocks start dropping out of the price index later in the year. The key issue now is, of course, the possibility of second round effects in the shape and form of wage rises, and the danger is that a dynamic may be set in motion which will be hard to put a brake on, especially given the tightness in the labour market, the inward movement of funds which will accompany any sustained raising of interest rates, and the availability of cheaper euro denominated currency loans at cheaper rates should the ECB start to head south just as the Czech central bank keeps heading north. In other words what has been a fairly benign win-win situation with interest rates and the Koruna up to now could very easily invert into a lose-lose dynamic.

Czech Central Bank Raises Main Interest Rate

The Czech central bank raised its main interest rate for a fifth time since May today in a bid to bring the inflation rate down to its 3 percent target by next year. The rate-setting board lifted the two-week repurchase rate a quarter point to 3.75 percent at this year's first session.

The inflation rate climbed to 5.4 percent in December, the highest in more than six year, beating the central bank's prediction for 3.9 percent.


The koruna was trading at 25.623 per euro as of 2:14 p.m. in Prague, compared with 25.582 in yesterday's late trading.

The statistics office may say tomorrow the January inflation rate soared to a nine-year high of 6.5 percent, based on the median estimate of 15 economists. The central bank's October outlook, which will be revised today, put annual price growth at 4.4 percent to 5.8 percent in September and 3.1 percent to 4.5 percent in March 2009.

Czech borrowing rates, which are the highest in six years, are still the lowest in the European Union, trailing the European Central Bank's main lending rate of 4 percent. Futures trading shows investors are betting on the repo rate to peak at 4 percent by June, which would end a 2 1/2-year rate-rise series.

Demand for higher wages from employees who see their buying power eroded from accelerating inflation may thwart the expected drop in the rate back to the central bank's target of 3 percent, plus or minus a percentage point, even after the effect of one-time tax increases and jumping food and oil prices ebbs.

The koruna's almost 12 percent appreciation against the euro since July is helping tame inflation by slashing import prices and weighing on exports. In addition, the economy is seen to grow 4.7 percent this year, after 6.1 percent in 2007, led down by household spending, the Finance Ministry estimated on Jan. 31.

Starting this year, the central bank is reducing the number of monetary-policy sessions to eight from 12. It will also start publishing minutes showing how individual board members voted on rates and will present a non-binding path of future interest rates as suggested by its inflation prediction.

Today, the central bank also decided to increase the discount rate to 2.75 percent and boost the Lombard rate to 4.75 percent. All changes take effect tomorrow.

Czech Employment and Unemployment Q4 2007

According to data released last week by the Czech Statistics Office, In Q4 2007, total employment grew by 105.6 thousand year-on-year to reach the highest level achieved in the last eleven years. The number of employees rose by 97.4 thousand and of the self-employed by 10.2 thousand. The number of unemployed - according to ILO methodology - was down by 86.5 thousand year-on-year, while the number of long-term unemployed fell by 62.3 thousand. When compared with Q4 2006, the general unemployment rate in the age group 15-64 decreased by 1.7 percentage points to the lowest level since the end of 1997 (4.9%).

Employment

The number of first (main) jobholders in Q4 2007 was 4 967.3 thousand, up by 105.6 thousand more (+2.2%) year-on-year. Employment thus reached it highest level since the start of 1997.




The number of working secondary school graduates with the maturita examination increased significantly (+66.6 thousand), and employed university and higher professional school graduates were also up (+28.1 thousand). This seems to be associated with a rapid growth in the education level of the young Czech population.

The number of employees increased by 97.4 thousand year-on-year to 4 155.1 thousand and their share in total employment was 83.6%. The number of the self-employed including family workers recorded a year-on-year rise of 10.2 thousand to 798.7 thousand and the share of the self-employed sector in total employment slightly decreased compared to Q4 2006 and reached 16.1%.

The growth in total employment largely took place in the secondary sector (industry incl. construction) where the increase of persons in employment (+73.1 thousand) was nearly twice as high as the increase in the entire tertiary sector (all services incl. transport). Employment grew the most in manufacturing (+60.7 thousand); the Czech Republic has the highest percentage of people employed in manufacturing (28.8%) among all the EU countries.

Employment rate

This is the proportion of first (main) jobholders in the total 15-64 age group, and it reached 66.5% in Q4 2007, up by 0.9 percentage points year-on-year. Male and female employment rates grew by 1.3 percentage points to 75.5% and by 0.5 points to 57.4% respectively. The increase of first (main) jobholders was partly offset by a drop in the number of second jobholders (decrease by 13.7 thousand to 83.3 thousand).




Unemployment

The average number of unemployed - using ILO methodology - decreased by 13.6 thousand quarter-on-quarter (seasonally adjusted). The total number of unemployed reached 252.8 thousand (of which 143.6 thousand were females), which was the lowest level since the mid-1997. In comparison to Q4 2006, the total number of the unemployed decreased by 86.5 thousand (-25.5%).




Generally, unemployment dropped more rapidly among persons in the young and middle working age groups. Male unemployment dropped more (by 44.9 thousand), especially in the five-year age group 20-24 (by 10.4 thousand). Female unemployment decreased by 41.6 thousand year-on-year, most in the young age group 20-24 (by 11.6 thousand). A majority of all the unemployed (71.5%) are persons with secondary education without maturita examination and persons with basic education.

The number of persons unemployed for one year or more decreased by 62.3 thousand year-on-year to 122.8 thousand and their percentage is below half of all the unemployed (48.6%). This percentage of the long-term unemployed is still high within the EU. An extraordinarily high percentage of persons out of work for a long time can be found in the group of the unemployed with basic education (65.1% of all unemployed persons with basic education); in the group of unemployed persons with secondary education without maturita examination the percentage is 46.2%. The total number of persons unemployed more than four years decreased by 8.7 thousand to 49.5 thousand (19.6% of the total number of unemployed persons).

Unemployment Rate

The general unemployment rate according to the International Labour Organisation (derived for the age group 15-64) reached a ten-year minimum of 4.9% in Q4 2007. Compared to Q4 2006 it decreased by 1.7 percentage points. The general unemployment rate in the Czech Republic is in the long-term below both the EU25 average and the euro area average.

Czech Republic Foreign Trade December 2007

The Czech Republic posted its first trade deficit in four months in December as demand for Christmas gifts bolstered imports and exporters reduced production during the holiday season. The full-year surplus was however in surplus and the value rose to a record. The deficit of 1.1 billion koruna ($64 million) was the smallest December shortfall ever, and compared with a 11.3 billion-koruna surplus in November and a 3.7 billion-koruna deficit a year ago, the Prague-based statistics office said earlier this week.

The full-year surplus was a record 86.1 billion koruna, and was largely driven by orders for Czech-made vehicles, machines and home equipment from other European Union countries. This has its good side and its bad side, since this EU dependence of course makes the Czech economy vulnerable to any EU wide slowdown like the one we are now entering. The 2007 surplus more than doubled from 39.8 billion koruna a year before, and the koruna rose to a record 25.580 per euro on the news.




Exports in December were up 5.2 percent on the year to 178.3 billion koruna. The value was down some 20 percent from November and the smallest figure last year, seasonally this is not surprising On the whole of 2007 they were up 15 percent on 2006.

The other 26 EU countries bought 14 percent more Czech products in 2007, while local exporters last year shipped 21 percent more goods to neighboring Slovakia.

Imports in December rose at an annual 3.6 percent to 179.4 billion koruna. The whole year goods trade surplus shrank however by 1.9 billion koruna on 2006, largely as a result of rising household spending. Czech imports increased by 13 percent in 2007 when compared with 2006.

So the drop in the trade surplus in December is not surprising given the time of year, but if we look at the year on year rate of increase in both imports and exports (see chart below) we will see that these have been slowing steadily since the summer, and this could be something of a warning signal, especially if conditions deteriorate in the main export destinations.





Bloomberg quote Michal Brozka, an economist at Raiffeisenbank AS in Prague, as saying:


"Besides the strong koruna, Czech exporters will suffer this year from the faltering economies of our main trading partners and from domestic conditions such as higher interest rates and a tightening labor market, which is pushing for higher salaries"

I think this is the main point, especially as the labour market tightens (see my next post) since Czech unemployment is now at its lowest level in more than a decade, causing a dearth of workforce in the economy and threatening to trigger accelerated pay rises.


In addition, due to inflation concerns the central bank is expected to raise its benchmark interest rate to 3.75 percent this week in a fifth increase since May, although it remains to be seen whether in the short term this has the desired effect of cooling the economy, or simply serves to attract more capial inflows and to encourage more Czech citizens to start contracting swiss franc or euro denominated loans as interest rates start to fall elsewhere.

IMF Says Czech Borrowing Rates Need to Increase

The Czech Central Bank needs to raise borrowing rates due to the problem of accelerating inflation, the International Monetary Fund said in its an Article IV Consultation summary published on its Web site today.

Economic performance remained strong in 2007, supported by continued robust growth of domestic demand. The current account deficit widened, but remained largely financed by inflows of direct investment. With vulnerabilities limited, the economy weathered the international financial market turmoil with minimal spillover impact. The strong economy boosted job creation while unemployment declined and capacity utilization reached record high levels. In this environment, inflation pressures mounted on account of higher domestic demand amid tightening labor markets as well as food and regulated price increases. Monetary policy was tightened in the second half of the year, although policy rates remain among the lowest in the EU.

Inflation is expected to almost double to above 5 percent, owing to food, energy and indirect tax increases, as well as demand and wage pressures. Risks of higher inflation expectations feeding into wage and price-setting remain while a slower pace of koruna appreciation could also increase inflation pressures. Shaping expectations is thus critical, especially with the planned lowering of the inflation target to 2 percent by 2010.

Directors commended the authorities on their prudent monetary policy, and supported the recent policy tightening to counter rising inflation pressures. With inflation set to rise to well above the target of 3 percent, Directors stressed the importance of ensuring that expectations remain well anchored to the inflation target through further timely monetary policy action. The appropriate pace of monetary tightening will depend, inter alia, on the degree of koruna appreciation and second-round effects of indirect tax and energy and food price increases. The planned downward shift in the inflation target to 2 percent from 2010 underscores the importance of preserving the Czech National Bank's high credibility. In this context, Directors encouraged the authorities to build further on welcome recent steps to enhance the transparency of monetary policy communication.

Given the looming population ageing problems the summary also suggests that the Czech Republic should look for a ``sustainable'' budget policy while giving the pension system a "comprehensive" overhaul.

In view of the coming challenge of population aging, Directors reiterated the importance of early and comprehensive pension and health care reforms. Along with the welcome increase in the retirement age to 65 years, complementary reforms to raise the effective retirement age and promote reliance on private pensions will also be needed. Directors welcomed the introduction of co-payments in health care as a step that should help contain excess demand pressures.

Czech Retail Sales November 2007

Czech retail sales growth slowed to an annual growth rate of 4.7 percent in November as accelerating inflation erodes spending power, and the economy slows slightly. Sales compared with an annual expansion of 7.9% percent in October, the Czech Statistical Office said today.



Inflation in the Czech Republic, which rose to an annual 5 percent in November from only 1.3 percent in January 2007, appears to be discouraging discouraged people from spending as did an outlook for government expenditure cuts and higher indirect taxes which entered into effect this month. This slowdown in retail sales, and other areas of economic activity, may allow the central bank to adopt a more "wait and see" approach about whether or not to procede with more increases in its benchmark interest rate, now at 3.5 percent.



Retail sales, including cars and motor fuels, rose by 5.9 percent from a year earlier the statistics office said. Sales and maintenance of cars jumped 8.4 percent, helped by this year's changes that have made leasing terms less favorable.

Household spending has been the main engine of gross domestic product growth - which has remained at over 6 percent for the past 10 quarters and concerns about overheating had prompted the central bank to lift what had been the European Union's lowest interest rates four times last year.

Retail sales growth may well slow this year as social spending cuts, an increased value-added tax on food and apartments and a rise in the average inflation rate bite into people's purchasing power. Inflation may well rise in 2008 to between 5 percent and 6 percent, compared with 2.8 percent in 2007, according to many estimates. The Czech central bank continues to keep the possibility of a further rate increase on the table due to concerns that the current pickup in inflation, may trigger wage demands and prevent a decline of consumer-price growth to the banks 3 percent target range.

Czech Current Account Surplus November 2007

The Czech Republic posted a surprising current-account surplus in November as import growth slowed and foreign investors doing business in the Czech Republic sent less profit home. This was the first surplus since March, and reached 1.2 billion koruna ($774 million), compared with a 13.7 billion-koruna deficit in October and a 10.9 billion-koruna gap a year ago, according to data from the central bank earlier today.

The Czech current account typically worsens in the middle of the year as foreign investors collect dividends and profit shares from local companies. Later in the year, the improving trade balance outweighs the effect of the dividend outflow. However it seems probable that higher investment income will continue to be a burden to the current account, which will almost certainly be in the red for most of 2008.

Czech Republic To Hold Fire On Euro Membership

Monetary policy experts in the Czech Republic are having second thoughts about the advisability of adopting the euro in the near future, based presumeably on the experience of those who have gone for rapid euro convergence. According to central bank board member Robert Holmanhe the Czech Republic is "not ready" to adopt the euro because giving up the koruna could cause the economy to overheat, (he has obviously been looking over his shoulder at what has been happening in the Baltics, Bulgaria, Romania etc).

The koruna's appreciation against the euro has lifted prices near the level of those in countries that have been European Union members longer, Holman wrote in a commentary in Mlada Fronta Dnes newspaper today. Losing the ability to allow the the koruna to appreciate would be reflected in a quickening pace of inflation, he said. This may not be exactly the situation, but he is scratching in the right area, and loss of control over monetary policy - as we are seeing now in the cases of Ireland and Spain - can create special "overheating" problems, which when corrected may produce a mini boom-bust type cycle.

``We would have to live with European interest rates that would undoubtedly be too low with regard to higher domestic inflation,'' Holman said in the article. ``Our economy would overheat, which could have fatal consequences.''

This is basically what appears to have happened in the cases of Ireland and Spain with their domestic housing booms based on long periods of negative real interest rates. Holman said that once the Czech Republic enters the so-called exchange-rate mechanism - which basically offers a pre-entry test of currency stability before the switch, a commitment will have to be made to limit the koruna gains, and this could well lead to an acceleration in price growth which would not be appropriate to the low interest environment. I think Holman has a strong point here, and I think it is one which did not receive sufficient thought before Spain and Ireland were admitted - since they were always liable to have a lengthy period of rapid catch-up growth where a rising currency would have been more appropriate.

"A country that is only going through a process of real economic convergence with the euro zone cannot fulfill the low- inflation and currency-stability criteria at the same time,'' Holman wrote. He also added that once the Czech Republic gives up its own currency all ``economic shocks'' will be transmitted to unemployment and inflation. "That is not a good alternative for our employees and consumers....It's better to have a domestic currency with a flexible exchange rate."

Of course we could call this learning by doing, but I would say better late than never. For a day by day insight into the kind of mess that can result from not heeding Holman's warning can be found by following events on this blog about Spain, and starting particularly with this post.

The Czech koruna rose to a record against the euro for a second consecutive day yesterday as investors bet the central bank will raise the European Union's lowest interest rates to stem accelerating inflation.



The koruna, the best emerging-market performer this year, gained versus 14 of the 17 most-traded currencies as a report yesterday showed Czech inflation accelerated to 5.4 percent in December, exceeding the central bank's target for a second month. Policy makers now seem set to lift the key benchmark rate at some point in the not too distant future, possibly in February.

Annual inflation last month accelerated to the fastest since August 2001.




The koruna was also underpinned by a larger-than-expected trade surplus, which widened in November from the previous month as imports grew at the slowest pace in 19 months. The surplus was at 11.3 billion koruna ($641 million) compared with 8.6 billion koruna in October, according to the statistics office data released today.

Czech Trade Surplus November 2007

The Czech trade surplus widened in November from October as imports grew at the slowest pace in 19 months. The surplus widened to 11.3 billion koruna ($641 million) from 8.6 billion koruna in October and 5 billion koruna a year ago, the Prague-based statistics office said today.



Czechia probably posted a record trade surplus for the third year in a row in 2007 on the back of mounting demand from European Union countries for Czech goods.

Exports increased 11 percent from November to 233.9 billion koruna, the lowest growth rate since August 2006. Imports grew 8.2 percent to 222.6 billion koruna.




The cumulative positive balance for the January-November period amounted to 87.2 billion koruna, a 43.7 billion-koruna increase from a year ago.

Czech Inflation December 2007

Czech inflation accelerated in December above the central bank's target for a second month, increasing pressure on policy makers to raise the benchmark interest rate as early as next month. The inflation rate rose to 5.4 percent from 5 percent in November, the highest since August 2001, the Prague-based statistics office said today.



Food prices were 1.8 percent higher in the month and 11.2 percent more than in December 2006, compared with a monthly 4 percent increase in November. Automotive fuel prices grew a monthly 0.8 percent, less than the 2.9 percent rate in November.

The central bank is weighing whether the inflation pickup from rising food and fuel costs and higher taxes justifies an increase in borrowing costs or whether the koruna's 10.2 percent advance against the euro in six months will quell inflation. The bank projected an inflation rate of 3.9 percent for last month.

The koruna advanced to 25.996 per euro by 1 p.m. in Prague from 26.057 yesterday, trading near a record high.


Inflation topped the upper end of the central bank's target of 3 percent plus or minus one percentage point for a second month. The benchmark two-week repurchase rate of 3.5 percent remains the European Union's lowest even after four increases last year.

The inflation rate may breach 6 percent in January, reflecting an increase in the lower valued-added tax rate to 9 percent from 5 percent, growing energy and state-controlled prices, a higher excise tax on cigarettes and the introduction of health-care regulatory fees and green taxes, economists said.

Monetary-policy makers hope that once temporary influences fade away, annual price growth will return to the targeted level starting from 2009. This hope may not be fulfilled should workers start demanding compensation for accelerated inflation at a time when unemployment is the lowest in a decade. It may also thwart the central bank's view that inflation will slow again this year and return to below 4 percent in early 2009.