Czech central bank's new forecast to show jump in rate path

PRAGUE (Reuters) - New Czech central bank inflation forecasts out next week will raise the prospect of several rate hikes in the coming year due to a weaker currency and greater inflationary pressure from the domestic economy, the head of the bank’s monetary department said.

The bank’s board raised interest rates last month, earlier than its previous forecast had assumed, and the new quarterly forecast will pencil in more expected tightening, Tomas Holub told Reuters in an interview.

The forecast is not binding guidance for rates but it is an important document for the bank’s policy-making board.

The exchange rate is a major variable for its predictions.

The bank’s last forecast from May predicted the crown would keep firming against the euro. But global sentiment has seen it weaken in recent months, despite the rate hike in June.

The crown has traded around 25.85 to the euro in the past days - about 4 percent weaker than the bank’s average forecast for the third quarter.

“At the point the exchange rate went in the entirely opposite direction, it autonomously. ..started relaxing monetary conditions. That of course creates room for us to go a larger distance on the path toward monetary policy normalization via interest rates,” he said.

“Inflation - quite a lot higher than we had expected - is adding to that.”

The bank was the first in the region to embark on a tightening cycle last year, and has since delivered four hikes to bring the main repo rate to 1.0 percent last month.

Holub’s comments echoed hawkish statements by two policymakers released on Tuesday.

Asked if the new forecast may show 100 basis points in hikes more versus the previous one in the year ahead, Holub said:

“(The implied trajectory) will rise rather in the shorter horizon where our May forecast suggested stability of rates,” he said, while in the longer term the aim was a policy-neutral rate seen around 3 percent.

“The move higher in the shorter horizon: What you said is not an order away from how our models work... I cannot, this close ahead of the bank board meeting, say unequivocally yes or no, but this idea is not entirely out of the ballpark.”

The May forecast had implied a repo rate of around 1 percent only in the fourth quarter, and a further rise to around 2 percent by the end of 2019.

Holub said the crown being some 3 percent weaker versus the euro than forecast meant one 25 basis-point move in rates in the bank’s model if the deviation lasted for one quarter. But the crown was now weaker for a longer period and the outlook did not suggest a sudden change, which he said multiplied the impact.

“I would intuitively say that if we observed only what we see in the domestic economy...we would be discussing that making one extra interest rate increase would be roughly sufficient. But the exchange rate is adding to this...the reassessment is based more on the exchange rate than the domestic economy.”

Inflation jumped to 2.6 percent in June, above the bank’s 2 percent target and 0.7 percentage point above the bank’s forecast. Holub attributed two-thirds of the spike to external factors such as fuel and food prices, and the rest to domestic pressures that are relevant for policy.

Reporting by Jan Lopatka; Editing by Hugh Lawson