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Czech economy heading for deflation

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The Czech economy is the closest to deflation it has been in the past six years. Year-on-year inflation decreased to 0.3% in July, the lowest level since September 2003. Analysts fear a price decline could come in September or in October.

A year-on-year drop in prices sounds attractive to customers, but it scares economists, especially when the economy is already in crisis and needs a boost. Deflation does exactly the opposite. Falling prices raise the value of money, so businesses and households hoard it rather than spending or investing it and boosting the economy.

“The chance that we experience deflation this year is about 50-50,” Patria Finance analyst David Marek said. There is no threat currently of the economy slipping into a deflationary spiral at present, however, as happened in Japan in the 1990s, he added.

“It will just be technical deflation. We will experience a year-on-year decline in prices for a while after six years of growth,” Marek said. It will not be the result of lower consumer demand, but rather a comparison with last year’s high commodity prices, he added. Marek agrees with other analysts that prices will start growing again towards the end of the year.

The oil risk
“There will be a different base of comparison at the end of the year. Oil prices are now pushing inflation down, but that can change at the end of the year,” Atlantik FT analyst Petr Sklenář said.

Last July, crude oil and other commodities reached record highs. Towards the end of this year, the year-on-year decline in prices will be less dramatic, or even reversed. Current oil prices are roughly half those of a year ago but still twice those of December 2008.

“Crude oil is one of the risky groups,” Sklenář said. Nevertheless, its future fluctuations should not have a major effect on inflation in the following months because of a delay in prices of energies tied to oil.

Natural gas reacted to the decline in oil prices with a price decrease in July and is now having an anti-inflationary effect. Electricity should join the trend in January, with analysts expecting its price to drop 7%.

Waiting for the harvest
Food has had a considerable effect on bringing average prices down in recent months. Prices for baked goods, vegetables, fruit and dairy products have fallen for several months in a row.

“What happens next depends mainly on the harvest,” Marek said. Analysts and bankers at the Czech National Bank perceive this important segment of the consumer basket as a big unknown.

“This is a very volatile segment of inflation,” said Sklenář. He forecasts, however, that food prices could settle in the coming months and that inflation could return to around 1% at the end of the year.

Analysts say that the inflation outlook does not provide the central bank with any room for more interest rate cuts. The Czech National Bank slashed its main rate to an all-time low of 1.25% last week in reaction to the economic slowdown.

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