OECD Economic Outlook, Volume 2018 Issue 1

Czech Republic

Economic growth will remain robust in 2018 and 2019. Increasing wages and employment will keep household consumption growth high. Private investment growth is also projected to increase thanks to favourable credit conditions. External demand will remain high, driven by growth in trading partners.

Inflation will stay slightly above the target of the central bank, driven by accelerating wages. Following the interest rate increase in February 2018, monetary policy should raise interest rates only gradually as inflation remains close to its target and avoid creating a gap vis‑à‑vis the euro area rate. Fiscal space is ample to boost infrastructure investment and address spending needs in education, R&D, vocational training and ageing related spending to prepare for the future.

Demand is driving growth

The growth increase in 2017, driven by both internal and external demand, was more balanced than in previous years. Household consumption is high, supported by income growth and a declining saving rate as confidence and credit have been rising. Private investment also increased markedly, driven by manufacturing and ICT investment (which also raised imports of investment goods) and a continued recovery in profits. Exports also kept expanding thanks to improved growth in trading partners.

The unemployment rate has continued to decline up to 2018 and is among the lowest in the OECD. Indeed, labour shortages are becoming the main constraint to growth. Job vacancies have increased and businesses are reporting difficulties in recruiting. Wages rose at a rate of 7% in 2017 leading to increasing unit labour costs and contributing to a pick‑up in inflation. In addition, increasing oil prices raised inflation temporarily.

Tensions in the labour market could limit growth

Labour shortages, accelerating wages and its effect on inflation are the main forces behind current economic developments. Wage increases will continue in 2018 and contribute to maintaining inflation above the central bank’s target. However, following the decision in April 2017 to abandon the exchange rate floor, the koruna has appreciated, tempering inflationary pressures, particularly for imported goods and services. As these effects fade out, inflation will remain slightly above the target. Indeed, the transmission of wage growth to prices remains limited and growth of food prices is expected to moderate. Monetary policy should raise interest rates progressively and monitor closely the inflation impact of the developments in the labour market.

Czech Republic

Source: OECD Economic Outlook 103 database ; and Eurostat.

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The stance of fiscal policy has been appropriately restrictive in 2017 in the context of strong growth and inflation. Public investment will increase further in 2018 with the acceleration of the EU funds disbursement. Government spending is increasing slightly faster than GDP, boosting domestic demand but the primary surplus remains large. The government should use the available fiscal space to invest in education, vocational training, R&D and innovation to reduce skills mismatch and stimulate labour productivity.

Czech Republic. Demand, output and prices

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Persistent employment growth and increasing wages have attracted many inactive people into the labour market, helping to cushion the decline of the working‑age population. Higher participation of women in the labour market, especially women with young children, would further increase labour supply and inclusiveness. In particular, part of the high spending in cash benefits for families could be directed toward formal childcare services and pre‑school facilities.

Growth is projected to slow but will remain above potential

Economic growth is projected to slow in 2018 and 2019, but remain above that in more advanced European countries. Strong household consumption growth supported by rising wages and employment will remain the main driver. Exports are expected to remain high but the growth rate will slow compared to 2017. Inflation is projected to fall and stabilise around 2% as the transmission of wage growth to prices remains limited. Risks stem equally from internal and external factors. Labour market developments could drive a bigger slowdown of growth than expected. Further increases in loans for house purchases and in house prices are a risk for the banking sector. On the external side, the Czech economy is particularly exposed to any disruption on trade given its high inclusion in global value chains.