Czech economy gets taste of deflation but prices seen returning upward

10-11-2009

Prices are falling in the Czech Republic according to the latest official figures. While that might seem to be a cause for celebration for shoppers the phenomenon of deflation usually sends a chill down the spine of economists and politicians. We look at the latest figures and the deflation danger.

For the first time in more than six years Czech prices went into reverse in October. Compared with a month earlier and with October 2008, goods in shops were 0.2 percent cheaper according to the Czech Statistical Office.

While that might seem like good news for those with money in their pockets and a shopping list in their hands, falling prices or deflation is a fearful phenomenon for economists.

The fear stems from the reasonable assumption that consumers will hold off buying anything if they think they can get it cheaper tomorrow than today. Such long term behaviour — in essence a shopping strike — would spell disaster for any advanced economy.

Fortunately for the Czech Republic, October’s price data is seen as a one-off, partly caused by current low prices for commodities and fuel compared with high levels a year ago.

David Marek is chief economist at Prague-based brokerage Patria Finance. He says normal service of upward bound prices should resume shortly in line with the expectations of the Czech National Bank or CNB.

“Annual inflation should reach the level of 0.5 percent, maybe 1.0 percent, by the end of this year and then go higher close to the CNB target of 2.0 percent. Because of changes to tax rates, VAT and excise taxes, it should even exceed the CNB target and be in the region of 2.0 to 3.0 percent by the end of next year.”

The prospect of higher prices in the pipeline poses another problem for the Czech National Bank. It is currently keeping an eye on what is probably a bigger and more immediate problem — the recent strengthening of the Czech crown to what are near year long highs against the euro and US dollar. The crown’s strength is contributing to keeping down the price of imports but also threatens to smother hopes for an economic recovery next year by making exports more expensive.

While a cut in already low interest rates could help weaken the crown it would probably help fuel those longer term price increases. Economists usually reckon that it takes 12 to 18 months for interest rate changes to have a full impact on the economy.

Patria’s David Marek again: “If the Czech crown should continue to appreciate, I would expect at first verbal interventions — some words from central bankers against strengthening. Then there is the possibility of an interest rate cut, but not by more than 25 basis points.”

That would take the main interest rate to 1.0 percent, the same rate as in the eurozone.

10-11-2009