Czech Republic: first country in the region to enter recession

In the third quarter, the Czech economy recorded its first contraction in quarterly terms since the first quarter of 2021 and is the first country in the region to open the door to a winter recession. Leading indicators show that the situation continues to deteriorate. Nonetheless, we expect the economy to return to growth early next year. We expect inflation to peak in October, slightly above September’s figure (18% YoY). Government measures to reduce energy prices in the fourth quarter should help to artificially lower inflation.

In terms of monetary policy, nothing has changed in our view. We expect interest rates to remain unchanged until at least the end of the first quarter of next year, then depending on inflation and the performance of the economy, we see the possibility of reopen the discussion on rate cuts. Although we consider the Czech Republic to be the first country in the CEE region to end its hike cycle, we see moderate risks of further rate hikes stemming from higher wage and labor growth. cost of currency intervention, which we will continue to monitor closely.

More interesting is the situation on the budgetary level, where the government recently approved an increase in the state budget from CZK 280 billion to CZK 375 billion (5.2% of GDP) for this year and to CZK 295 billion CZK (3.7% of GDP) for next year. In addition, a number of proposed changes on both the revenue and expenditure sides have not yet been approved, adding to the uncertainty surrounding an increasingly expansionary fiscal policy.

On the market side, the selling pressure on Czech government bonds eased, however, given the increased supply of bonds, questions on fiscal policy and the risk of a deterioration in sovereign rating, we think CZGB will suffer more. The Czech koruna, on the other hand, remains entirely under the control of the central bank. Although the costs of the Bank’s intervention in the foreign exchange market are increasing, we believe that the cushion is still large enough and do not expect any change in the coming months.