Present at the meeting: Josef Tošovský (Governor), Zdeněk Tůma (Vice-Governor), Miroslav Hrnčíř (Chief Executive Director), Luděk Niedermayer (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director)

The bank board opened its regular meeting with a discussion of the current economic situation. Attention was first given to the new information that has developed during the two weeks since the extraordinary board meeting on 11 March 1999. New data on the Czech economy were presented, concerning mainly GDP and foreign trade. Significant changes have also occurred in the area of external factors.

According to data on GDP in 1998, economic performance has significantly declined. Data from the previous quarter, though, should be assessed in relation to the deviation from the trend in Q4 1997 where GDP rose by 2.2%. Seasonally adjusted quarterly data indicate some acceleration of domestic demand, private and government consumption and to a certain extent, also investment activity. While it was indicated that GDP corresponds to the CNB estimate, acceleration of private and government consumption was identified as new information which reduces the likelihood of continued economic decline.

In connection to this, the difficulty in interpreting the link between retail sales and private consumption was mentioned. Attention was also given to the savings rate and clearing up the significance of the savings rate indicators published by the Czech Statistical Office and the CNB. Opinions were expressed that the savings rate shows a tendency to decline which, given the falling interest rates from deposits, could continue. It was indicated, though, that according to CNB indicators the savings rate is still relatively high.

It was expressed that the gap between domestic supply and demand has shown up in declining net export. In constant prices, the quarterly deficit was one of the largest since the beginning of transformation. The external balance in current prices, nevertheless, is much lower. This difference can be attributed to the unique development of the terms of trade in 1998. If this year's terms of trade take on a different character, this could cause the external balance to worsen, in current prices as well.

The board now turned its attention to the exchange rate. Indications were given that the exchange rate level which had developed during the first months of 1999 corresponds to the situation in the economy, and the new exchange rate level was a desirable consequence of lower interest rates, supporting in turn Czech export competitiveness. More exchange rate movement has occurred recently. The discussion focused on whether the exchange rate is still searching for a new level or whether recent developments should be understood as volatility that will be followed by corrections.

Interpreting the developments as volatility was supported by the views suggesting a foreign exchange market affected by the activities of some important clients and also by the war in Kosovo. In support of the hypothesis on a new level, it was stated that, given a lack of other positive news, any stimulus causing a correction in volatility would probably not occur. In relation to the discussion on exchange rate movement, it was also stated that in a situation of declining foreign demand, it is not very likely that exchange rate depreciation would be reflected in export recovery. In addition, the external balance could be worsened by renewed domestic demand.

Higher crude oil prices were considered to be very important new information. As long as the other commodity markets follow the trend of the oil market or as long as crude oil prices continue to rise, import prices can be expected to send inflationary impulses in the Czech economy. The first reaction in the form of a rise in some domestic prices has already been observed.

After assessment of the new information, the bank board continued with a more general discussion on the possibilities of monetary policy given the current economic situation. It was stated that the setting of monetary policy parameters has undergone significant development in past months, and the decisions made during the last bank board meeting completed for the most part the manoeuvre period of monetary policy adaptation to the new phase of inflation development. Future meetings will more than likely involve corrections of current settings.

A possible resurgence of the external imbalance was indicated as one problem that economic as well as monetary policy could face in the future. In relation to this, it was stated that an adequate economic policy response in the given conditions is to switch expenditures instead of reducing them, which was the strategy used in 1996. This is due to the fact that the situation is different and the economy does not show any signs of positive growth. It was also suggested that monetary policy contributes to closing in the gap between domestic supply and demand by cutting investment activity costs.

The bank board continued by assessing the inflation risk factors in relation to the inflation target for 1999. On the basis of the most recent data on GDP, it is no longer possible to rule out inflationary pressures caused by domestic demand. This pressure could be supported by real wage growth whose impact on price development was significant. In addition, external factors have begun to give rise to inflation risk which will probably be reflected in import price growth. It is likely that the exchange rate will still search out a new level.

At the close of the meeting, the CNB Bank Board unanimously decided not to change the setting of CNB monetary policy instruments, and interest rates were left at their current levels.

Author of the Minutes: Kateřina Šmídková, CNB, Council of Advisers

Comments are welcome on the following email address: Katerina.Smidkova@cnb.cz