## Thursday, August 03, 2017

### ČNB finally notices that the Czech economy is overheated

Europe's first rate hike in many years

Since the November 7th, 2013 anniversary of the Great October Socialist Revolution, the Czech National Bank (ČNB) artificially weakened the Czech currency and kept it weaker than 27 crowns per euro. During the 3+ years up to April 6th, 2017 when the cap was finally abandoned, the Czech National Bank quadrupled its Forex reserves so right now, Czechia's $143 billion of foreign reserves make us the 18th "most reserved" country in the world, almost tied with Italy, and safely beating the likes of the United States of America or Europe (ECB). ;-) Ms Emmy Destinn née Kittlová (almost like Motlová) on our$90 banknote. She and Dinh Gilly uploaded a nice audio to YouTube in 1914 with the Czech anthem, 4 years before it became the anthem. The lyrics were a bit different.

The CZKexit came too late – but it was because the board members had unwisely extended a commitment back in 2016. On April 6th, there was no doubt that it was needed to remove the weird Chinese-style policy. Since that time, the EURCZK rate went down more or less smoothly from the cap level of 27 to 26 or so, confirming all my qualitative predictions and debunking many analysts' delusions about "a huge volatility with rate jumping between 24 and 30" and similar crackpottery.

Today, the analysts were already aligned with my predictions and a slight majority of them expected a rate hike today. At 1 pm today, the Czech National Bank indeed published their decision to make the first rate hike in Europe in recent years. The key "2T [=two-week] repo" rate was lifted from 0.05% (our "technical zero") to 0.25%. It was the first Czech rate hike since 2008.

The crown only appreciated modestly, by some 0.5%, to 25.95 per euro or so. Note that because the euro has strengthened vis-a-vis the dollar, the strengthening of the Czech crown relatively to the U.S. dollar looks rather dramatic. The dollar went from 26 in January to CZK 21.9 now.

Mojmír Hampl, the ČNB board member whose transformation into a "treacherous dove" in late 2013 made the interventions barely possible, wasn't participating at the meeting today. He could be proposing to delay the first rate hike. The remaining six members were probably more reasonable.

One of the arguments of the ultra-doves is that the European Central Bank will wait before it hikes the rates for the first time. I think that this argument is rubbish. ČNB isn't controlling the European currency, it's only controlling the Czech one and that is used in the Czech economy. That economy differs from the European one – and pretty dramatically – so the rates should be changed differently and at different moments, too. We and our ČNB just can't be just a parrot of some guys in ECB.

The fundamental reasons to hike the rates are obvious. The inflation is around 2.5%, robustly above the 2% target even though it's still within the 1%-3% window. But truth to be said, Czechs' optimally optimistic inflation rate would be a deflation around 1%-2%.

Perhaps more importantly, the Czech unemployment rate is 2.9% now, by far the lowest one in Europe. Germany is second – at 3.8%. For quite some time, Czechia and Germany would display a statistical tie but as you can see, it's no longer the case. The two numbers differ robustly. The European average is around 9% while the Greeks are closer to 20%. Czech companies are struggling to find employees and there are huge pressures to increase the wages.

Aside from the widespread economic optimism (and the correspondingly fast increase of the people's spending for better food, very fast increase of prices in restaurants etc.), the increase of the wages – which include the public sector due to the populist government – are likely to cause additional increases of the inflation rate in the future. I personally find the 2.9% unemployment rate pathologically low. The availability of workers is important for the economy to work well. I would probably consider the 5% rate to be better than 2.9%.

On top of that, the decade of the cheap money has kickstarted another real estate bubble. In recent year or two, the Czech houses' and apartments' prices are growing by some 15% a year – which is also the robustly highest rate in Europe. The increasing rates have a chance to make mortgages a bit less accessible and reduce the demand for apartments.

Because of all these reasons, the today's rate hike could also be said to be too little, too late. The increase by 0.5% would have been better today. But at least they got the correct sign today.