Komercni banka a s : Komercní banka's macroeconomic forecast: 2015 - A year of fiscal and monetary expansion

Prague, 29 July 2014 - - The Czech economy has set out on the upward leg of the economic cycle. The recovery, which is broadly based unlike 2010 and 2011, is gaining momentum. The Czech economy is expected to reach its pre-crisis level in late 2014. The persisting low-inflation environment will help the central bank to continue in its relaxed monetary policy in 2015 too. Following the fiscal restrictions last year, the easing is visible this year, and we expect a stronger fiscal impetus next year. Economic growth will result in the rate of unemployment declining even more, and a faster growth in wages.

We have revised the growth outlook for this year upwards by one full percentage point to 2.9%, and for 2015 expect the economy to grow by as much as 3.3% (compared with the originally expected 2.6%). The reason for this revision for 2014 is, in particular, the unexpectedly good performance for the first quarter of this year, when the GDP rose by 0.8% qoq. The improved outlook for 2015 is based on a stronger fiscal expansion and, thanks to the recovering investment activity, a higher growth of the potential product.

Economic growth is based on broad fundamentals and we continue to expect virtually all economic sectors to contribute to this growth. The driver is industry, where the volume of output began increasing as early as July 2013 thanks to stronger export activity. This is clearly a result of the improved economic situation in Germany and on the markets of some other of our trade partners. We expect industrial production to grow in real terms at an annual rate of 6.6% this year and next year. Following five years of decline, we expect growth in the construction industry, by 6.2% in real terms. Next year, this sector may even improve by more than 10%, helped by fiscal expansion, companies' stronger investment activity and also the development in the residential housing market. Farming should also perform well in the light of the encouraging forecast for this year's harvest. Not least, the sector of private services is also expected to feel greater activity.

The structure of growth in 2014 and 2015 is expected to be balanced also from the perspective of demand. Thus, the recovery will probably have a different nature than in 2010 and 2011 when the main driver was net exports, and it presages the sustainability of this favourable development.

• Fixed investment will no longer be restricted by fiscal consolidation this year, and the construction industry, the recovering property market and growing industrial production are expected to begin to support investment activity gradually. Investments were stifled for a long time, but production capacities are now utilised at a level of the long-term average. Fixed investment is therefore expected to grow by 6.5% this year after last year's 3.5% contraction, and the growth may even be 6.8% next year.
• Household consumption is primarily supported by low inflation this year, which will be behind a 1.9% growth in real wages (nominal growth 2.3%). The situation on the labour market no longer hinders household consumption. At the beginning of this year, the rate of unemployment already started to decline slightly on a seasonally adjusted basis. Household consumption is set to rise by 1.5% on average this year, the most since 2008. The figure is to be 1.9% next year. This will, naturally, also help retailers, for whom we expect a 3.3% growth in sales this year, encouraged by sales of automobiles in particular to the corporate sector. In 2015 we expect retail sales to grow by as much as 2.4% in real terms.
• Thanks to strong external demand, we expect a positive contribution of 1.3 pp to GDP fromnet exportsthis year. Next year, this contribution is expected to decrease to 0.6 pp. On the one hand, the price-related competitive advantage will gradually be reflected in the real numbers thanks to the CNB's intervention regime; on the other hand, however, stronger internal demand will prompt higher imports. This is especially true for investments, which are more import intensive compared with consumption.  

Already this year the fiscal policy has started to support economic growth and we expect a major positive contribution in 2015. The measures presented by the Cabinet will support, our simulations indicate, investment activity the most and household consumption to a lesser extent. However, the downside is an even deeper public finance deficit (from last year's 1.5% of GDP to 1.7% this year and as much as 2.4% in 2015). On the other hand, the government debt should grow only slightly thanks to using the government's liquidity reserves. Indeed, the expected economic growth should actually reduce the debt to GDP ratio (last year 46.0% of the GDP, while we expect 43.9% this year and 42.5% next year).

Despite the major depreciation of the Czech crown, this year's inflation will be the lowest since 2003, only 0.4% on average. We have revised the inflation outlook for this year downwards by 0.4 pp. For the first six months the year-on-year consumer price hikes stayed at 0.2% on average; the central bank was therefore successful in preventing deflation. For the rest of this year, we already expect inflation to rise slightly towards 0.7% by the end of this year. Nevertheless, the low-inflation environment is expected to persist in 2015 when we predict an average rate of inflation of only 1%. Among other factors, the abolishment of the regulatory charges in the health sector and the expected further decrease in electricity prices will be behind the low inflation.

The CNB will not exit the intervention regime before the third quarter of next year. This should be a controlled process to ensure that the central bank avoids the risk of the Czech currency subsequently strengthening dramatically. For the rest of this year, we expect a stable rate of exchange oscillating around CZK 27.40/EUR; in 2015, initially a slight appreciation towards the CZK 27.00/EUR defended by the central bank, while in late 2015, in the wake of the exit from the intervention regime, we expect the Czech crown to appreciate to around CZK 26.35/EUR.

We see two fundamental risks for our macroeconomic forecast:

• External, should the Ukrainian crisis deteriorate even more, and/or the fall of the eurozone's economy into recession;
• Internal, if the Cabinet fails to push through the fiscal expansion in the form that we expect.

Source: Economic & Strategic Research, Komerční banka.                                                                 

Note: (*) external trade as per cross-border statistics; (**) inflation components net of primary impact of tax changes

Jan Vejmělek
Chief Economist, Komerční banka
Tel: +420 222 008 568
jan_vejmelek@kb.cz