Present at the meeting: Josef Tošovský (Governor), Oldřich Dědek (Vice-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 the meeting by assessing the accuracy of interest rates in relation to achieving inflation targets. In this context, the macroeconomic outlook for 1999 and 2000 was also discussed. According to the baseline scenario, a slight recovery in demand will occur within this time frame. After a certain time lag, supply will also show signs of recovery. It is expected that the disequilibrium in supply and demand will not increase to a large extent. Hence, there would not be a significant risk of inflation acceleration or of a rise in the current account deficit. The factors not affected by monetary policy directly create a favourable environment for price stability. Some of the factors that are still developing more favourably than originally expected in the last period include commodity prices, the current exchange rate, and food prices. According to the baseline scenario, reaching the medium-term inflation target for the year 2000 is realistic considering that there is a risk of undershooting the target for 1999 due to the factors mentioned above. At this time, though, room exists for lowering rates.

A number of views were expressed pointing to the risks involved with the baseline scenario. These risks could lead to underestimating the potential for imbalance. The decline in GDP has been mainly caused by a fall in investment, which is structural in nature and reflects reductions in excessive capacities. Due to the current structural changes, it is difficult to predict whether improvements in supply will occur fast enough to prevent an imbalance on the goods market as demand starts to make a comeback. Some important indicators show that the recovery in demand should be higher than the baseline scenario indicates. Increases in household incomes should be carefully watched due to the potential pressures that could develop as a result. Money supply growth will also be analysed. For this period, money supply growth in relation to the specific growth structure of this aggregate is becoming a more relevant indicator than credit growth. Fiscal policy is expansive. It is possible that demand recovery will be difficult to sustain in view of its structure. It was also stated that favourable food price development in the longer run does not need to be sustainable due to the low profitability of this industry.

Other comments during the meeting stressed that the baseline scenario could lead to overestimating the potential for imbalance. Money supply growth will not necessarily create demand pressure on the goods market, but could affect the stock market. As long as demand recovery occurs first in the next period, demand's lead over supply will have a significantly lower impact on the development of imbalances than it had in a period of economic growth. The central bank should not obstruct the process of demand recovery, and therefore, it is important to keep exports competitive. It was also stated that one of the reliable indicators of economic recovery in the past was raising budget revenues through indirect taxes, which so far has not taken place. The latest economic information on inflation for May and on GDP for Q1 was also mentioned. This information indicates that it is very difficult to formulate inflation forecasts on the basis of historical experience, because the present economic situation is formed in internal as well as external low-inflation conditions. This fact along with last year's disinflation process contributed to lowering domestic inflation expectations.

The Bank Board also examined the issue of capital inflow. The koruna exchange rate has appreciated once again. Further development in this direction presents uncertainty for monetary policy decision-making. Appreciation, though, could have been triggered by the privatisation of CSOB and therefore, might be only temporary in nature. On the other hand, it was mentioned that global capital flow has begun to return to emerging markets. It was stated that it might be necessary to compare the current situation with experiences from 1994 and 1995 and to carefully consider the alternatives of economic policy. One way to respond to capital inflow might be with market instruments, because membership in the OECD does not allow the use of some regulatory measures that could obstruct capital inflow, as for example in some South American countries. Even though the central bank has the capacity to intervene, isolated intervention strategy would not be efficient enough nor consistent with economic policy aims. An adequate reaction to capital inflow could be to correctly set the mix of all economic policies far enough in advance so that costly policy corrections do not have to be made at a later time.

At the end of the meeting, the Bank Board decided unanimously to lower the CNB two-week repo rate from 6.9% to 6.5% (by 0.4 percentage points), effective 25 June 1999.

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

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