Czech inflation surprised to the downside in June, mainly due to a sharp drop in food prices. We expect neither the headline nor the core rate to get out of hand in the forecast horizon, despite anticipated renewed growth in food prices. With the economy still operating below its full potential, we see policy rate stability as the base case scenario.
Food prices likely to bottom out yet headline set to behave
Czech headline inflation came in well below expectations at 1.5% year-on-year and -0.3% month-on-month in June. The main source of surprise was the pronounced decline in food prices, reflecting the continued deepening annual decline in agricultural producer prices. Nevertheless, recent harvest estimates suggest a subdued staple grain harvest. Due to the spring drought, farmers expect a 16% lower grain harvest from a year earlier and a 12% lower harvest compared to the five-year average.
That said, the harvest is just beginning, and crop estimates will gradually become more precise. Still, we expect food prices to bottom out and to flip into an annual growth cycle during the fourth quarter of 2026. This reflects the anticipated renewed growth in agricultural production prices that are about to peak at around 8% annual growth mid-next year. We expect that food prices will gradually cease dampening headline inflation and will turn pro-inflationary over the upcoming year.
Food prices will turn pro-inflationary
The fuel price drop was likely also more pronounced than we had foreseen, although the potential for further significant drops seems somewhat limited, given the expected paths for Brent crude and exchange rates. We still pencil in two more declines in fuel prices for July and August, but that should be all. Annual price growth in services slowed down to 4.5% in June (from 4.7%), and price dynamics in goods prices flipped into an annual decline of 0.4% in the same month.
With such readings, we estimate that annual core inflation has eased to 2.8% in June. In our view, the core rate should touch 3% only early next year, but is set to hover below the inconvenience zone otherwise.
Benign headline vs elevated core inflation this year
Taking the latest developments on board, the headline inflation average will likely land below the target this year at 1.8% on average, while rising somewhat above the 2% threshold on average next year. We see both the average headline and core rate at 2.5% next year, with punchier food and regulated price dynamics.
Rates to remain unchanged for some time
All in all, the Czech National Bank's mandate is to ensure price stability, as measured by headline inflation. In our view, this condition is met over the monetary policy-relevant horizon, with headline inflation remaining within the tolerance band around the target. As such, we do not believe the Czech economy currently requires tighter monetary policy.
The economy has yet to reach its potential output sweet spot, which was likely pushed further out by the recent turmoil in the Middle East. While greater prudence may be warranted once industry and the wider economy are operating at full capacity, we do not believe we have reached that point yet.
We therefore expect the CNB to keep rates unchanged at 3.75% at its August meeting. This view is further supported by the fact that real interest rates remain comfortably positive and are likely to stay above 1%.
Czech economy can sustain positive real interest rates
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