The Czech economy expanded by 1.3% q/q in Q1 and by the robust 2.9% y/y in Q1, according to the flash estimate of the Czech stats office published on Tuesday. The quarterly growth was much above market expectations for 0.7% q/q increase. The annual growth speeded up from 1.9% y/y in Q4 2016 and was also much above analysts’ estimate for 2.3% expansion. What is more important though is that it is well above the CNB’s projections for 2.5% y/y expansion in Q1, which indicates that faster monetary tightening may be needed. The finance ministry is slightly more downbeat putting it at 2.3% y/y.
The stats office said that the economic growth in Q1 was supported mainly by foreign demand as indicated by high-frequency data as well and by household consumption. The latter in our view reflects the favorable labor market developments with the unemployment rate falling and wages increasing due to the good situation of firms, but also the increasing shortages of labor. It has been already manifested in retail sales growth accelerating in Jan-Mar. Note that however the growing labor shortages is considered as potential major impediment to economic expansion in the medium term. The stats office also said that employment was higher by 0.6% q/q and by 1.5% y/y, which indicates that the economy is in quite good shape and continuing to create new jobs. However, the annual increase in employment creation slowed down from 2.1% y/y in Q4, which is indicating that the investments are needed to boost production capacities. At the same time, we do not expect the investments to have recovered from the slumps reported last year (6.9% y/y contraction in Q4) as the EU funds drawing is still slow, which hurts mainly public, but also private investments. Still, the latter may have continued benefitting from the loose monetary policy conditions in Jan-Mar, while the above-average production capacities utilization and narrowing labor market may have prompted companies to invest even more. The accelerating pace of expansion of imports in Jan-Mar may be indicative of such a development. At the same time, growing upward wage pressures to secure qualified staff may have limited the companies’ resources for a significant expansion of investments. Statisticians also said the preliminary data have been indicating that most industries of the economy expanded, with economic activity in both manufacturing and services improving performance. Monthly data showed that the construction output contraction has eased markedly, so we may expect that the sector’s drag on the economic expansion has declined in Q1.
The CNB has revised its projection for GDP growth in Q1 to 2.5% y/y in the latest May forecast from 2.4% projected in February, while the finance ministry is more downbeat cutting its projection to 2.3% y/y in the April forecast from 2.7% projected in January. From monetary policy point of view, the stronger than projected Q1 GDP growth bodes well with the CNB’s conclusion that the economy is close to its potential and needs certain monetary tightening. Yet, as the central bank has numerously said since it ended its fx commitment on Apr 6, it would welcome the expected crown’s firming to deliver part of the needed monetary tightening before engaging with policy interest rates hikes. However, given that the estimated Q1 GDP growth is stronger than the CNB forecast, that the crown has been appreciating only modestly, while inflation is seen to accelerate again above the 2% target driven by upside wage pressures amid narrowing labor market and labor shortages, may be indicative that sooner tightening of monetary conditions via interest rates is needed and warranted, in our view. Recall that during the last May 4 monetary policy meeting the rate-setters concluded that if the crown remains weaker than forecasted and fails to deliver part of the needed monetary tightening, there might be greater room for interest rate hikes (currently seen to start in Q3 only). Still, central bankers have admitted that it would be better inflation to overshoot the target for some time than to precipitate with rates hikes, and have argued that the fact that the CNB ended its fx cap earlier than previously envisaged (around mid-year) required to leave the crown to find its new equilibrium level.