PRAGUE, May 25 (Reuters) - The Czech central bank needs to keep interest rates above standard levels, support the government in cutting budget deficits and urge wage restraint to avoid mostly supply-side inflation from spilling to the demand side, incoming Governor Ales Michl said in a magazine interview. Michl, whose appointment by President Milos Zeman was a surprise given his opposition to the bank’s year-long campaign of raising interest rates, reiterated he would propose keeping interest rates flat for some time after he takes over in July.
“Supply-side inflation will fly through the economy and nobody in the world can do anything about it,” he told the weekly Ekonom.
“The Czech National Bank should communicate it as an exception from fulfilling the inflation target,” Michl said. “The key is to prevent it becoming demand-side inflation.”
He said he expected inflation to peak around 15% in July, and that it would take two years to return to the 2% target.
The central bank has raised rates by 550 basis points to 5.75% since last June and is expected to raise them further on June 22, when the board meets for the last time under outgoing Governor Jiri Rusnok.
Its policy department included more rate hikes in the near future in its forecast last month but even the current board opted for a more moderate approach, closer to an alternative scenario seeing smaller increases and a slower decline in inflation.
President Zeman has not said whom he would appoint to three other seats on the seven-member board that will be open from July. The other appointments will be key to determining how strong a hand Michl will have.
The incoming central bank governor said a sharp drop in the crown exchange rate following his appointment - to which the bank reacted by selling euros from its large reserves - was the result of a reaction by traders who interpreted Michl’s comments at his appointment ceremony to mean interest rates would not go as high as they had expected.
Michl also said he would seek to raise returns on the bank’s large foreign assets - worth 161 billion euros ($172 billion) - gradually over years, raising the proportion of stocks in the bank’s portfolio to over 20% from the current 16%. He cited actions by the Swiss and Israeli central banks or the Norwegian sovereign fund as examples of a similar approach.
He said he also wanted to sharply raise gold holdings to 100 or more tonnes over time from the current 11 tonnes for diversification.
The aim is to make profits that, after the bank covers past losses and replenishes its reserve fund, would go into state budgets, Michl said. The profits would have to exceed the costs of domestic repo operations and any losses from a firming exchange rate, he said. ($1 = 0.9367 euro) (Reporting by Jan Lopatka; editing by Jonathan Oatis)
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