(An effect of this sort was clearly at work in the last Inflation Report forecast: weaker equity prices led the Committee to revise down its forecast of domestic investment, partly offsetting the effect of a shallower yield curve on the projection for GDP growth.) But the impact of such swings seems to be larger on market yields than on actual forecasts of interest rates. The red line in Chart 6 plots the gap, in months, between the date of the first UK rate rise implied by the sterling yield curve and that expected by professional forecasters. When the line goes up, markets are pushing out this “lift-off” date further than analysts. And you can see this tends to happen when risky assets do poorly (the blue line is an estimate of the risk premium). Conversely, the gap narrows when risk appetite improves. This pattern suggests that market interest rates might be influenced by more than the expected path of interest rates 6. To be clear, the MPC produces its forecasts on the yield curve as it is, not what it believes the market’s true expectation of future interest rates to be. So the fact that the two might differ does not, in and of itself, invalidate the sort of inferences we’ve been talking about. But it should, at the least, make one a little careful about describing the yield curve as “the market’s expectation of future interest rates”.
In spite of the fact that there has long been a significant surplus of liquidity in the Czech money market, this lack of confidence caused a deterioration of the proper functioning of the market. The Czech National Bank launched the liquidity-supplying facility in October 2008. Czech government bonds were made eligible as collateral in these operations. This technical measure was aimed at limiting the potential spreading of problems from foreign financial markets to the Czech financial sector. The situation calmed down at the end of 2008. Overall, the financial crisis itself has had only a limited primary impact on the Czech financial market due to its low exposure to toxic assets and focus on domestic business in local currency. Nevertheless, the country was affected by an increase in risk aversion to the whole of Central and Eastern Europe, due mainly to the problems of some countries which needed financing from abroad. The Czech Republic is among the countries that provide loans to some of them or participate in lending schemes organised by international institutions. The financial crisis has led to a significant decrease in global economic activity. As the Czech economy is very open and export-oriented, the loss of demand from major trading partners was reflected in weaker domestic economic activity and therefore banks became more cautious in providing credit to the business sector and subsequently to households. Weak foreign demand is thus probably the most severe factor stemming from the global financial crisis that is affecting the Czech economy.