Czech Republic: Profligate fiscal loosening will push up bond yields

We think the Czech 10-year bond yield is on track to breach 5% in the coming months, as the markets continue to price in the fiscally profligate programme of the new government. We think the yield will eventually settle around 5.2% in late 2026. As a result, we’ve downgraded Czech local currency bonds to underweight in our Emerging Markets Asset Allocation.

Based on the government’s relatively vague programme manifesto, we expect fiscal loosening of around CZK100bn-CZK150bn annually (1.2%-1.5% of GDP). This would push the budget deficit to 3.5% and put debt-to-GDP on an upward trajectory that would hit the 55% debt brake in early 2030s.

Most of the fiscal loosening is tilted to current spending and transfers, with limited tax cuts and public investment. We think the measures have relatively low multipliers and will provide only a modest boost to growth and inflation.

As a result, we don’t expect the Czech National Bank to counter the fiscal expansion with rate hikes. However, the bank is likely to settle on a mildly restrictive monetary stance for longer. This should also mean the fundamentals-driven gradual appreciation of the koruna continues, helped by the positive rate differential.

Given low government indebtedness, fiscal sustainability isn’t at risk. However, the government is likely to squander the opportunity afforded to it by the cyclical upswing and fiscal space. Rather than short-term demand support, we suggest the economy needs structural reforms and investment to offset the slowing potential output growth and shift up the value chain.