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Czech bonds rallied after inflation release

Czech bonds rallied after inflation release

15.2.2007 9:54

The Czech fixed market rallied yesterday, as the January inflation readings came out much lower that the market expected, notably at 1% m/m, whereas the market expected 1.6% m/m. The result is thus closer to the estimate of the central bank, which assumed an increase in prices of around 1.2 %. Recall that year-on-year inflation fell from 1.7% in December to 1.3% in January.

The unexpectedly low January inflation result is primarily the result of a lower increase in regulated prices associated with housing, primarily the largely symbolic increase in net rent and certain other housing costs, with the exception of natural gas. This indicates that not even the partial relaxation of regulated rents resulted in a significant increase in housing costs and thus inflation, although one cannot rule out the possibility that rents will increase further at the start of the second half of the year. The second reason for the lower than expected price increase is the delay in the price increase for cigarettes, which is only very slowly reflected in inflation, but inflation will increase in the months to come. Altogether, last year’s increase in excise duty for cigarettes should increase inflation by 0.6 of a percentage point. The movement of other prices in the consumer basket was no surprise. There was a seasonal increase in food prices, and in contrast the prices dropped for clothing and petrol, which reduced transport costs. The change in calculation, when the statistical office changed the structure of the consumer basket, also played a minor role.

In our view the low level of inflation in January indicates that the CPI will probably remain under the CNB target for most of the year, and the CNB will therefore not have to increase rates in the first half of the year. As a result we have to rewrite our outlook for the CNB repo rate for this year. Previously, we had thought that a next rate hike could come in April while the second 25 bps should be added in October. Now we think that there will just one 25 bps rate hike this year delivered probably in the last quarter of this year.

Today, the bull-run on the Czech fixed-income might continue as Fed’s Benanke assessment of the US economy should be positive both for bonds and emerging markets. However, the gains at the short end of the curve and money market might be limited after the very strong rally yesterday.

ČSOB - Investment research

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