The scenarios

Over the past 50 years, continuous rate increases have been observed in developed countries, including the Czech Republic, which have always led to a recession. In this article, the question arises whether this time the dynamic will be different.

Institutional thinking envisages a scenario called ‘soft landing’, which differs from the baseline scenario in that it foresees a return of inflation to desired levels and slow but steady growth. The alternative scenario could be the so-called ‘hard landing’, which, on the other hand, could show a much lower growth profile and rates falling from peak levels much faster.

Reasons for and against the ‘soft landing’ scenario

Therefore, one wonders why the scenario should be different this time. According to the optimists, there are several reasons why inflation could return to desired levels: first, they expect energy and food prices to fall, and another motivation concerns the high amount of cheap money in circulation that finds many bank loans stuck at low-interest rates. Then, there is a demographic motivation where an ageing population and a shrinking labour force have caused pressure on wages, thus making the labour market tight. Another factor relates to the normalisation of flows in global logistics with the need to return to pre-pandemic standards. Finally, the profitability of many companies has been vitiated by the margins obtained from the difference between the purchase prices of the inputs needed for business and their subsequent resale.

On the other hand, there are factors why the scenario may not be right. Firstly, inflation still exceeds nominal rates thus encouraging spending, secondly, pandemic savings will soon disappear where consumer spending is aligned with disposable income, and, fiscal gears will reverse as student loan payments restart. Finally, there is an asset/liability time mismatch where not onlybanks butut but also some corporations earn higher rates. Despite the rate hikes, the net interest payments of US corporations have decreased, as many corporations locked in low-interest rates on their debt in 2020 and thus now earn much higher returns on their cash. This positive mismatch between assets and liabilities, however, applies mainly to large companies, while smaller ones are hit much harder by borrowing costs.

Focus on Czech Economy

The Czech economy, unlike the US or Eurozone economies, already went through a mild recession in late 2022 and early 2023, as households restricted consumption due to high inflation and rising interest rates. The Czech National Bank (CNB) sees a recovery in household consumption as positive, allowing the economy to grow by 2.5 % in 2024 and 2025.

Moreover, Czech inflation fell to 8.5% in August and is heading towards the CNB’s target of 2% by the beginning of 2024, where the key drivers of disinflation from the 20% peak are the weakening of energy and food prices.

As for interest rates, the CNB left rates unchanged by a unanimous vote on 4 August, prompting markets to expect a rate cut, which then came on 27 September, thus adjusting to the disinflation path.

Source: https://www.camic.cz/it/

Source of image: https://businessday.ng/

Graphic sources: https://storyset.com/