Prague - The Czech National Bank on Thursday 6 November slashed its benchmark interest rate from 3.5 percent to 2.75 percent, surprising the market, which expected a cut by only 0.25 percentage points.

Analysts say the strong crown, an expected slowdown of the Czech economy and ebbing inflation are the main reasons behind the move.

"The last time the ČNB adopted such a sweeping rate cut was in summer 2002. Like today, the move came after a period in which the crown was very strong," says Raiffeisenbank's Michal Brožka.

The Czech currency's exchange rate to the euro dropped by CZK 0.20 to CZK 24.90/EUR immediately after the announcement, but firmed to CZK 24.79 in the early afternoon.

"It is obvious that the ČNB's move was prompted not only by the slowing economic growth and the expected inflation decrease, but also by the stress and growing rates on the interbank market of the past few weeks," says Patria Finance economist David Marek. "From this point of view the ČNB's move can be seen as very smart."

Time to warm up economy

Lower interest rates may provide some relief for the economy by cutting the cost of borrowing money.

"Domestic and external inflation pressures have weakened, opening space for cheaper loans that would in turn bolster economic activity," Patria Finance analyst Tomáš Vlk told Aktuálně.cz.

It remains uncertain how retail banks will react to the move. The global credit crisis has prompted much more conservative lending policies, which make loans increasingly expensive.

Česká spořitelna and Komerční banka told Aktuálně.cz they and other Czech banks are watching the situation on the interbank market and in the next few days will decide whether to modify their interest rates too.

Credit markets still lack confidence

"Until the global and domestic financial markets return to the state they were in before the fall of Lehman Brothers, a reduction of ČNB's rates will not have a significant influence on the interest rates in retail banks," says Raiffeisenbank analyst Helena Horská.

"Banks are now facing significantly higher costs of raising cash and they are trying to attract more savings. If they cut their rates at all, it will be only a tiny reduction," says Horská.

Vlk says that retail rates will only decrease after a "restoration of confidence on credit markets and further rate cuts by the ČNB".

Analysts expect the Czech central bank to adopt more rate cuts next year.

The European Central Bank on Thursday cut the euro area's main interest rate from 3.75 percent to 3.25 percent.

Bank of England on the same day slashed the UK's key rate from 4.5 percent all the way to 3 percent, shocking the market, which only expected a cut by 0.5 percentage points.