Prague, 31 January 2013 - The Czech economy fell into a recession at the beginning of last year. The domestic economy is likely to have remained in recession throughout 2012 as we anticipate a slight drop (-0.1% qoq) in 4Q12. Even though the recession is not as deep as in 2009, the current downturn is the longest in modern history. In combination with European debt problems and domestic fiscal consolidation, it results in an increase in pessimistic expectations of Czech companies and households. An unprecedented drop in domestic demand is an outcome of this.

In terms of real GDP, the Czech economy is likely to have deteriorated 1% in 2012 as the last quarter was also characterised by lower economic performance (we expect a decrease of 0.1% qoq, which implies the deepening of the yoy drop to -1.4% after -1.3% in 3Q12). The extreme pessimism of Czech households resulted in an unprecedented drop in household consumption (-2.8%, according to our estimates). Czech households were not as cautious as they were during the monetary crisis of 1998 or the global financial crisis of 2009. Domestic political and tax uncertainty and unclear outlooks for global demand also contributed to a slight decrease in companies' investment activity. Last year, net exports constituted the only positive contributor (2.2pp).

This year, the economy will be in the same situation as last year in terms of its real performance. Overall, we predict only a slight drop of GDP by 0.1%. The recession will continue in 1Q13. Starting in 2Q13, we expect a slight recovery driven by a gradually improving situation outside the country, and hence net exports. A positive contribution of net exports is expected to amount to 1.6pp this year. The balance of external trade will register a record-high surplus of more than CZK 380bn this year after last year's CZK 330bn.

In the first months of this year, household consumption will be dampened by the next wave of fiscal consolidation, which negatively affects households' disposable income in real terms. Also, the situation on the labour market, suffering from a slow growth of nominal wages, rising unemployment and higher uncertainty of job preservation, is contributing negatively. In the second half of the year, we expect a slight recovery of consumption thanks to the end of fiscal consolidation and an improved economic situation. However, the labour market will respond with a delay. As investment slowdown will continue this year (we expect a drop of 2.1%), the economy will not create jobs, rather the contrary. The share of the unemployed will increase to 8% by the end of this year (7.1% in December 2012). We forecast only a slight increase in household consumption at 0.4% in 2013.

Inflation is and will remain affected by cost factors. On the other hand, there are no demand pressures and none will exist in the short term due to the expected development of household consumption. Inflationary pressures do not stem from the labour market either, because wage costs rise very slowly. This year, we anticipate average consumer inflation at 2.3% after last year's 3.3%. This year's price development will be affected in particular by a tax hike, the impact of which we estimate at 0.9pp, and by a rise in regulated prices with an estimated impact on inflation of 0.47pp. In particular, rents and prices of electricity, gas, water and sewerage will grow.

The Czech currency's exchange rate also becomes the preferred monetary policy tool according to central bankers. The CNB will positively prefer the transparent creation of currency expectations to do its job instead of the CNB. And central bankers will thus avoid a direct FX intervention. For this reason, we have not regarded the risk of intervention as urgent so far. Should deflationary pressures strengthen and the current exchange rate does not reflect that, the risk will increase. We suppose this risk will grow as time goes on and deflationary pressures rise. Also for these reasons we anticipate a gradual CZK weakening towards a level of EUR/CZK 26.00 in 2H13 in our main scenario.

According to our prognosis, the public finance deficit will decrease to 3% of GDP (according to ESA95 methodology), which will help to stop Brussels from applying the procedure of excessive deficit against the Czech Republic. In 2012, the deficit will have stood at 4.9%. However, church property restitution as a one-off item contributes 1.5pp.

The major risks to our macroeconomic prognosis stem from the domestic and foreign economies. Domestic risk factors include especially the unstable environment (politics, taxes, etc.), negatively influencing the expectations of households and companies and resulting in a further weakening of internal demand. A possible deeper and longer-than-expected recession in the eurozone represents a major external risk to our prognosis.

Macroeconomic forecast 2012 2013 2014
GDP (real growth, yoy in %) -1.0 -0.1 1.4
- Household consumption (real growth, yoy in %) -2.8 0.4 1.2
- Fixed investment (real growth, yoy in %) -0.2 -2.1 -0.2
External trade (CZK bn) 327.4 382.7 434.0
Industrial production (real growth, yoy) 0.0 -1.9 1.6
Retail sales (real growth, yoy in %) -1.0 -0.8 1.6
Wages (nominal growth, yoy in %) 2.5 2.1 2.1
Unemployment rate (MPSV*, in %) 6.8 7.8 8.1
Inflation (yoy in %) 3.3 2.3 1.5
- Taxes (contribution to yoy inflation) 1.2 1.0 0.1
- Adjusted inflation (yoy in %) -0.1 0.0 0.7
- Food prices (yoy in %) 3.2 3.5 1.4
- Fuel prices (yoy in %) 6.0 0.3 1.0
- Regulated prices and taxes (yoy in %) 7.0 3.9 3.6
3M PRIBOR (average) 1.00 0.48 0.43
2W Repo (average) 0.53 0.05 0.05
CZK/EUR (average) 25.1 25.8 25.7

Source: Economic & Strategy Research, Komer

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