Bloomberg News

Czech Bargain Addicts Invigorate Push to Cut Interest Rates

June 27, 2012

Czech Central Bank Governor Miroslav Singer

Miroslav Singer, governor of the Czech central bank. Photographer: Vladimir Weiss/Bloomberg

For Ales Moravek, the ever-deeper discounts luring buyers into his outdoor equipment store are biting into profits. For central bank Governor Miroslav Singer, they are adding to reasons to cut borrowing costs this week.

A deepening recession is amplifying the Czech Republic’s traditional penchant for thrift and aversion to debt. Moravek, who co-owns a shop in Hradec Kralove, is among Czech retailers grappling with a shrinking market as fading consumer demand limits room to increase prices.

“It’s incomparable,” Moravek, 47, said in an interview in his shop 100 kilometers (62 miles) east of Prague. “We rarely used to have sales before. Now one campaign follows another. Discounts on boots end one day, discounts on camping equipment start the next. This basically runs the entire season.”

Faltering demand pushed Singer, the Ceska Narodni Banka governor, to seek a reduction in borrowing costs deeper below the euro-area benchmark in May. As the European Central Bank lifted and then lowered its main rate by half-percentage point to 1 percent last year, the Czechs have held rates steady at a record-low 0.75 percent for two years because consumers’ spending fell short of fueling inflation.

ECB Speculation

Forward-rate agreements fixing the three-month interbank rate in three-months were quoted at 0.99 percent today, compared with the Prague interbank offered rate, or Pribor, at 1.21 percent, according to data compiled by Bloomberg. The central bank’s two-week repurchase rate is 0.75 percent. The yield on two-year notes fell seven basis points to 0.9 percent at 3:59 p.m. in Prague, the lowest since at least 1997.

The ECB on June 6 kept its benchmark interest rate at 1 percent, and President Mario Draghi said “a few” policy makers called for a cut, fueling speculation the bank may act as soon as next month as the bloc’s debt crisis curbs growth. The Frankfurt-based ECB said in its monthly bulletin published on June 14 that economic growth “remains weak with heightened uncertainty weighing on confidence and sentiment, giving rise to increased downside risks to the economic outlook.”

Czechs shun debt as a way of boosting living standards or to bridge more difficult periods, helping keep household debt at about half of the euro-area level. Consumer confidence fell to the lowest in almost 13 years in May, while retail sales declined 4.1 percent in April, the largest decline in two years and compared with a 5.5 percent increase in Poland.

“The Czech mentality is to try to prepare for the negative possibilities rather than for the more optimistic ones,” central bank board member Lubomir Lizal said in a June 11 interview in Prague. “At the time of negative news, a typical reaction is to be even more cautious, to prepare for an even worse situation.”

Low Indebtedness

Household debt in the Czech Republic was 58 percent of gross disposable income and 30 percent of the country’s gross domestic product in 2011, according to central bank data. That compares with a gross debt-to-income ratio, a gauge of indebtedness in relation to the ability to pay back debt, of 99 percent and a debt-to-GDP share at 65 percent in the 17-nation euro region.

Premier Petr Necas has made slowing growth of state debt, which at 41 percent of economic output was half of the European Union’s average last year, a center-piece of his two-year-old Cabinet’s program. The plan to bring the deficit below the EU’s limit of 3 percent of gross domestic product has reduced the state’s funding costs, with the yield on the Eurobond maturing in 2021 falling to a record-low 2.925 percent on June 26. The yield was 2.940 as of 4:58 p.m. in Prague.

In the Czech Republic, price bargains are one of the main reasons for choosing grocery stores, according to a Shopping Monitor Survey by Incoma GfK. The overall price level in a store is the least important for Czech households among eight eastern European countries covered in the survey, including Bosnia, Poland, Hungary, Serbia, Slovakia, Bulgaria and Slovenia.

Disappearing Loyalty

“Compared with two or three years ago, what we are seeing is disappearing loyalty of shoppers toward their favorite stores,” Pavel Cabal, a researcher at Incoma, said in a June 21 interview. “The addiction to discounts has reached such a rate that sales campaigns are more important for choosing the store than consumers’ confidence in overall low price levels in their favorite shops.”

The Czech central bank chief differs in his assessment of inflation trends from policy makers in Poland, the EU’s largest post-communist economy. The Narodowy Bank Polski was the only bloc member to lift borrowing costs this year as inflation has exceeded the upper end of policy makers’ target range since January 2011. Singer is discounting a spike in inflation above the bank’s target, fueled by a tax increase and fuel costs, and focuses on consumers’ spending.

Tax Increases

Rate setters in Prague are assessing the impact of the government’s tax increases on shop prices and the effects of the euro area’s sovereign debt crisis on the economy. The central bank’s board split three ways over monetary-policy settings at the last meeting on May 3, with Singer and Vice-Governor Vladimir Tomsik seeking a rate cut.

The next meeting is on June 28 and Tomsik and Singer may not be alone anymore. Twenty of 24 economists in a Bloomberg survey forecast a quarter-point cut in the two-week repurchase rate to a record-low 0.5 percent.

“We are essentially stagnating because of, I believe, the uncertainty of almost every player in this economy, and because of fiscal measures that are necessary to keep our fiscal side balanced,” Singer said at a conference in Prague today. “Inflation-wise, we are not in a big trouble,” he said, adding the only sources fueling price growth are the sales tax increase and influences from outside the Czech Republic.

The economy contracted in the final quarter of 2011 and the decline deepened in the first three months of this year as weakening domestic demand outweighed rising exports after households cut spending. Price growth has exceeded the central bank’s 2 percent target for eight months as the government increased the sales tax to boost budget revenue.

Deflationary Policies

“The Czech economy isn’t growing because monetary policy is deflationary,” Lars Christensen, the chief emerging-markets economist at Danske Bank (DANSKE) AS said, adding the central bank had room to ease monetary policy. “In fact, the central bank’s policies have been deflationary and that’s why it shouldn’t be a surprise that the Czech economy shows a growth patter similar to Japan rather than as a catching-up economy.”

The May inflation rate dropped to 3.2 percent, the lowest this year, from 3.5 percent in April. The rate was 0.2 percentage points lower than the central bank forecast. Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, eased to 2 percent in May, matching the bank’s target.

Headline inflation may exceed the bank’s forecast of 1.5 percent in the second quarter of next year if the government pushes through another set of measures aimed at boosting the budget revenue, including an additional increase in the sales levy and a new rate for higher earners.

Higher taxes may further depress consumer spending next year and curtail economic growth, according to central bank forecasts. With less disposable income, pressure on retailers may intensify.

“Of course there is pressure on margins,” Moravek said. “The costs are increasing, while the prices are either staying unchanged, or rise only slightly. It’s getting much tougher to make a living.”

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net; Lenka Ponikelska in Prague at lponikelska1@bloomberg.net

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net; James M. Gomez at jagomez@bloomberg.net


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