In response to price growth well above the inflation target, the Czech National Bank (CNB) has repeatedly moved to raise the base interest rate. The expected result of the restrictive monetary policy is to halt price growth and restore confidence in the CNB’s ability to maintain price stability. Photo credit: Freepik
Czech Republic, Feb 11 (BD) – In its efforts to control inflation, the CNB has one unexpected assistant, in the exchange rate of the CZK against the euro and other foreign currencies used for international trade. The Czech economy is above average in international trade; more than 70% of what the Czech economy produces each year is exported, with a similar figure for imports. Import prices thus have a significant impact on domestic price levels.
The fall in import prices as an indirect consequence of rising interest rates helps to reduce inflation. However, this effect will not occur immediately. The effect of the CZK’s evaluation will become apparent when previous contracts expire, and consumer demand adjusts to lower import prices.
The revaluation of the Czech koruna reduces the income of Czech exporters. For every trade made in foreign currency they end up receiving a smaller amount in CZK. They can respond either by increasing the price in euros or pressing for a reduction in costs in Czech currency. In fact, many Czech companies first import goods from abroad and then export them again after processing. In this case, firms are naturally hedged against currency evaluation.
The evaluation of the CZK thus contributes to a return to the CNB’s inflation target in the medium term and brings the koruna closer to its long-term equilibrium. It also relatively improves the overall wealth position of the Czech Republic when expressed in foreign currency.
