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Friday, September 28, 2007

Czech Central Bank Maintains Interest rate

The Czech central bank kept its benchmark interest rate unchanged at the lowest level in the European Union's lowest level yesterday, after perviously raising it three times this year, citing in justification for the decision the stronger koruna and increased global borrowing costs.

At the close of the meeting, the Board decided to leave the CNB two-week repo rate unchanged at 3.25 %. All six board members present voted in favour of this decision.

Key Czech Economic Indicators

Price indicators:

- annual industrial producer price inflation in August (3.7 %)
- annual agricultural producer price inflation in August (15.6 %)

Leading indicators of growth:

- annual growth in retail sales in July (8.9 %)
- annual growth in industrial production in July (11.5 %)
- annual growth in construction production in July (-1.7 %)

External balance:

- trade balance in July (CZK -0.7 billion)

According the the bank press conference presentation:

The risks of headline inflation forecast are on the upside, risks of monetary-policy relevant inflation forecast are on the contrary on the downside.

Major risks and uncertainties:

- tax changes and faster expected growth of regulated prices
- faster then expected growth of food prices
- drop in market expectations of 1Y Euribor rate
- stronger koruna exchange rate against the euro
- lower August inflation and in particular adjusted inflation excl. fuels
- extent of fiscal restriction in 2008

Bank Governor Zdenek Tuma indicated at the press conference that the bank may reduce its forecast for future interest rates next month. Policy makers have previously said more increases are needed through 2008 to combat the effect of rising domestic demand and excise taxes. The koruna, which rose 2.1 percent against the euro in the past seven weeks, and the rising cost of credit, may have eased that concern.

``The koruna has been stronger than we anticipated in the latest forecast'' in July, Tuma said. ``There is a great question-mark'' over the impact of the global market turbulence on economic growth, inflation and monetary policy, which ``will be a subject to study'' in the next few months.

He also suggested that inflation adjusted for one-time effects is more likely to undershoot July's forecasts than exceed them, even as the headline inflation rate may rise higher than estimated.

The inflation rate rose to 2.4 percent in August from 2.3 percent in July, 0.2 percentage point below the central bank's forecast for that month.

"The monetary-policy inflation is what we react to directly...it is below our forecast ....Were we to evaluate that the secondary effects of tax and regulated-price changes..... we feel that will not be too significant, and that could theoretically lead to a somewhat lower interest rate trajectory"

Still, the central bank sees ``upside risks'' to its quarterly inflation forecast from rising taxes and regulated costs as well as from a larger-than-assumed jump in food prices.

The banker also expects an upward ``correction'' of inflation by the end of the year in the order of fractions of a percentage point after the impact of a new methodology on measuring inflation introduced this year led to unexpectedly slow price growth.

A reduced outlook for interest rates in the euro region, being one of the most marked effects of the turmoil on global markets, is also a risk to the bank's inflation prediction, according to the central bank chief.

The government's fiscal policy next year, which will be reflected in the October inflation prediction, may be more restrictive than expected, Tuma said.

The koruna has been the best performing emerging-market currency against the euro in the third quarter, reversing a trend from the first half when it lost 4.1 percent. It was trading at 27.595 to the euro as of 5:06 p.m. in Prague, compared with 27.620 yesterday.

The currency's gains cap inflation by making imports cheaper and undermining export revenue. The koruna is used for so-called carry trades when investors buy higher-yielding assets using loans taken out in currencies with low interest rates. With the recent aversion to risk on global credit markets, investors unwound those trades, buying back the koruna.

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