Česká národní banka

Minutes of the Board Meeting on 25 June 2003

Present at the meeting: Zdeněk Tůma (Governor), Oldřich Dědek (Vice-Governor), Luděk Niedermayer (Vice-Governor), Michaela Erbenová (Chief Executive Director), Jan Frait (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director)

The Board opened the meeting with a presentation of the 6th situational report on economic and monetary development. It was stated in the report that the effect of disinflationary cost factors still played a decisive role in consumer prices, especially oil prices and the exchange rate of the US dollar. In comparison to last month, the level of consumer prices had not changed. Within this framework, however, the rate of food price growth had increased to a certain extent while the continued decline in fuel prices worked in the opposite direction. Industrial producer prices were 0.8% lower in May than a year ago.

Data had been published since the last situational report showing higher economic growth than originally expected. This growth was most prevalent in the segment of household consumption. In addition, the trade balance results were better than the forecast had predicted, especially after certain corrections were made in the data. The rise in year-on-year lending (+4.5% in nominal terms) and the structure of lending corresponded to this situation. Household lending contributed most to this development, with year-on-year dynamics reaching 30%.

In this respect, the situational report focused in more detail on household indebtedness in the Czech Republic. It was revealed that the high dynamics of household lending was the result of changes in the supply of banks and other financial institutions, low interest rates and, in particular, the initial low base. In spite of the rapid development of lending, household indebtedness in the Czech Republic still remained below the level typical for EU countries. For banks, household lending is substantially less risky than corporate lending.

Very weak foreign demand accompanied by slowing price growth in the EU helped to sustain the low inflation environment in the Czech economy. In contrast, domestic demand was slightly higher than expected by the inflation forecast. However, even this factor could not be considered a significant inflation risk. Therefore, on the whole, the risks of not reaching the April inflation forecast were once again assessed by the situational report as being asymmetric in a disinflationary direction.

In the discussion to follow, board members agreed that the CNB's approach so far to lowering interest rates was considered to be effective. In an environment of very weak foreign demand, this had helped stimulate domestic consumption. It was impossible to have an immediate effect on unsatisfactory investment development with monetary measures alone.

Several views pointed to the gravity of the current disinflationary risks and their effect during the period of the most effective monetary transmission. Accordingly, a number of different stances examined the choices available for lowering interest rates or leaving the rates unchanged.

The unexpected improvements in data on economic activity this year was an argument in favour of leaving rates at their current level, e.g. GDP growth, industrial production and the trade balance results. It was pointed out that economic growth was concentrated in areas relevant for the future development of inflation: household and government consumption. One opinion expressed that another cut in rates could help create a bubble on the real estate market and an unwanted shift in real interest rates downward to negative values. Even the latest exchange rate developments for the koruna would not lead to tightened monetary conditions. With the impact of leaving lower VAT rates for the hotel and restaurant industry, the next inflation forecast would be shifted down. However, even afterwards, the year-on-year CPIs were expected to fluctuate in the upper half of the targeted band throughout all of next year.

It was reminded in support of lowering rates that the GDP growth figures did not mean yet that the output gap would close up, so its relationship to future inflation was not straightforward. It was also pointed out that the rise in household consumption in Q1 was aided by certain short-lived, temporary effects, such as indemnity payments or the previous term for wage corrections in the public sector. The prepared consolidation of public finances was indicated as being an important anti-inflationary factor, suppressing household and government consumption growth. The yield curves showed expectations of a rate cut of 0.25 points, so a decision to lower rates should not surprise the markets. It was also reminded that all European countries were dealing with the consequences of unsatisfactory growth in the EU and a weakening dollar, and many countries had reacted by lowering rates. One view expressed that if a rate cut were indeed feasible, then it would not be advisable or correct to delay such a decision.

The Board discussed the current account in detail. From the long-term perspective, the current account deficits were rising under the influence of the balance of services and the balance of income. As mentioned during the discussion, this involved the medium- and long-term risk for the future development of the exchange rate and inflation. For the short-term outlook, this risk was still small due to favourable trade balance developments. If the global economy recovered and some of the global risks were reduced, the balance of services should also show improvement. A worsening balance of income was the tangible outcome of previous privatisation and investment; the share of the distribution of profit in reinvested profit and in profit transferred to home countries was important for future developments.

Following the discussion of the 6th situational report, the Board decided by a majority vote to lower the CNB two-week repo rate by 0.25 percentage points to 2.25%, effective 26 June 2003. Four board members voted in favour of cutting rates by 0.25 percentage points, and three members were in favour of leaving rates unchanged. The Board also voted to cut rates by 0.5 percentage points; one member voted in favour and six against this proposal. The discount and Lombard rates were also lowered by 0.25 percentage points to 1.25% and 3.25%, respectively.

Author of the Minutes: Petr Krejčí, Adviser

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