MNI INTERVIEW: FinStab Changes Could Allow CNB June Cut - Kral

The Czech National Bank is likely to consider the use of macroprudential tools to slow the pace of house price growth when it meets this week, a move which ould allow it to cut rates further later this month, though its current hawkish bias means a hold is more probable, a former senior official told MNI.

Residential prices and imputed rents are increasingly relevant to the outlook for both core and CPI inflation, said former CNB monetary department head Petr Kral, with their continued strong rise likely to make his former colleagues “nervous”.

But with wage growth moderating - albeit from an elevated level - real consumption stuck below 2019 levels, and the output gap negative, there might be scope for a strategic trade-off between tighter macro prudential policy and easier monetary policy, he added.

Topics for discussion at June 5’s financial stability meeting are likely to include whether or not to adjust the counter cyclical capital buffer rate or the systemic risk buffer rate, as well as two borrower-based measures, the Debt-to-Income ratio (DTI) and the Debt Service-to-Income ratio (DSTI), Kral said.

“They might therefore recommend reactivating DTI or DSTI measures to calm down the housing market. I think only a minority of Board members would be resistant to doing anything regarding house prices. Plus, if you activate those measures you have more room for manoeuvre in the monetary space, at a time when the rest of the economy is not booming and inflation is below the target.”

SCOPE FOR EASING

Cautious easing would be consistent with negative demand pressures which are likely to become more pronounced over the relatively short horizon on which monetary policy operates, he said, adding that the CNB should be prepared to signal its willingness to loosen monetary policy further if necessary, though this seems unlikely at present. (See MNI EM INTERVIEW: More Room For Czech Rate Cuts - Ex-CNB Official)

"The yield curve is still relatively high and relatively flat. By letting the market push the yield curve downwards, which is effectively loosening monetary conditions, they can afford to keep short-term interest rates relatively high. Some Board members might therefore be happy that their conservative communication style is preventing the market from putting pressure on them to produce what they would see as a premature loosening of monetary conditions."

Inflation fell to 1.8% in April but could top 2% in May and June, before settling “somewhat above” 2% for the remainder of the year Kral said. The Board voted by 6-1 to lower the key two-week repo rate by 25bps to 3.5% in May, but said “persisting stronger inflation pressures from the domestic economy” meant room for more cuts was “limited.”

Another factor in the CNB's preference for hawkish rhetoric may be its new Executive Director of the Monetary Department, Petr Sklenar, whom Kral suggested will be more inclined to "hear the more conservative voices on the Board than those of the Department.

“If he exercises influence over both sides, there is the potential for the signal coming from the model to be somewhat lost in translation,” Kral said.

“At the same time, there are members of the Board who see those anti-inflationary, demand-side drivers of monetary policy as relevant, and as possibly exerting more influence on their decision-making over time.”

SPLIT DECISIONS

With policy rate at or close to Board members' estimates of the neutral rate of interest, future decisions may be more split than has been the case so far, Kral said.

“I'm not very sure whether the distribution of votes will be a spontaneous one, or whether this be a kind of strategic or tactical play with the markets - as it played out in many central bank boards across the world - to send a signal that views are more split than they were before as we approach a relatively more sensitive level of interest rates, and as individual Board members reassess their previous policy decisions.”

Policymakers will also be opportunistic in their ad-hoc deployment of domestic inflation expectations to make the case for looser or tighter monetary policy, Kral said.

“If inflation expectations are an argument in favour of the majority decision of the Board, then they will communicate that they take account of inflation expectations. In other circumstances they will be quiet on inflation expectations, especially on households’ inflation expectations, which are typically backward-looking.”