Česká národní banka

CNB > Monetary policy > CNB Board decisions > 2015 > 5 February 2015

Minutes of the Bank Board Meeting on 5 February 2015

Present at the meeting: Miroslav Singer, Mojmír Hampl, Kamil Janáček, Lubomír Lízal, Jiří Rusnok, Pavel Řežábek.

The meeting opened with a presentation of the first situation report and the new macroeconomic forecast covering the horizon up to the end of 2016. The Czech economy had expanded by 2.4% year on year in 2014 Q3, with all domestic demand components having made positive contributions. By contrast, the contribution of net exports had been negative. In quarter-on-quarter terms, economic activity had risen by 0.4%. Annual headline inflation had been 0.5% on average in 2014 Q4. The price level adjusted for changes to indirect taxes had risen only marginally in Q4. Both headline and monetary policy-relevant inflation had decreased in Q4, remaining well below the lower boundary of the tolerance band around the target. The fall in inflation had been due mainly to a sharp drop in world prices of oil and a decline in food prices. The pass-through of the weakened exchange rate of the koruna to inflation via import prices was fading, but the exchange rate was still contributing to growth in economic activity and a recovery in the labour market. The domestic economy had thus been fostering higher inflation for several quarters now.

The new forecast was based on an assumption that market interest rates would be flat at their current very low level and the exchange rate would be used as a monetary policy instrument until the end of 2016, i.e. over the entire forecast horizon. The subsequent return to conventional monetary policy would not imply appreciation of the exchange rate to the level recorded before the CNB started intervening, as the weaker exchange rate of the koruna was in the meantime passing through to domestic prices and other nominal variables. The forecast expected inflation to be at zero or slightly negative levels in 2015 and then rise to the 2% target in 2016. The anti-inflationary effect of import prices observed at the end of last year would strengthen substantially owing to a decline in producer prices in the euro area magnified by a sharp fall in energy commodity prices. In 2016, import prices would have a modest inflationary effect. The domestic economy would contribute to price growth over the entire forecast horizon as a result of a gradual recovery in wage growth and continued growth in domestic economic activity. Following a temporary slowdown in late 2014 and early 2015, GDP growth would accelerate gradually thanks to a recovery in external demand, still easy monetary conditions, the positive cost effect of low oil prices and a recovery in government investment. The domestic economy would grow by 2.6% in 2015 and pick up to 3% in 2016.

In the discussion that followed the presentation of the situation report, the Board assessed the risks to the new forecast as being balanced. There was a consensus that the degree of uncertainty associated with the forecast had increased. In line with the new forecast, the Board stated that the Czech National Bank would not discontinue the use of the exchange rate commitment as a monetary policy instrument before the second half of 2016. In this context, it was said that the shift in the exit date was not generating inflation pressures in itself but was creating conditions for the growing inflation pressures in the domestic economy to manifest themselves. The opinion was also expressed that the effect of exiting later on the inflation outlook might be limited. There remained a consensus that the appropriate reaction was to leave rates unchanged at technical zero.

The Board discussed in detail the effect of the slump in oil prices on domestic inflation and on its outlook and agreed that the appropriate course of action was to apply the system of escape clauses (i.e. exemptions from hitting the inflation target) to the first-round effects of this shock to the price level. This meant tolerating inflation moving close to, or even slightly below, zero this year. In this regard, it was said repeatedly that the system of escape clauses had been applied in the opposite direction in the past when oil prices had been rising. It was said several times that monetary policy was focused beyond the horizon of effect of the oil shock and that the first-round effects of the shock would dissipate during 2015, leading to inflation returning to the target in 2016. A monetary policy response would only be necessary if negative second-round effects of the oil shock were to materialise.

There was a consensus that the slump in oil prices was a positive cost shock for the domestic economy and would boost Czech economic growth in 2015. It was said several times that thanks to the low oil prices, growth would be stronger than forecasted in 2015. One of the reasons given for this was that the outlooks for the external environment, and especially for external demand, had not yet taken into account the positive effect of low oil prices and that this had had a downward effect on the GDP growth forecast for 2015.

In a discussion of the overall domestic economic situation, it was said that the economy was on a growth path and that growth in 2015 might be even stronger than forecasted thanks to a recovery in export markets. There was a consensus that it was relatively strong GDP growth, driven primarily by domestic demand, which represented the main difference between the current economic situation and that in November 2013, when the exchange rate commitment had been introduced. It was said several times that the introduction of the exchange rate commitment was one of the reasons for the turnaround in the domestic economy. It was said that had monetary conditions not been eased using the exchange rate in November 2013, currently observed inflation would be running at around the -2% level and the unemployment rate would be nudging record highs. It was also said that another indicator of this turnaround was core inflation, which was now positive.

The Board discussed the possible impacts of the actions taken by the ECB to counter the deflationary tendencies in the euro area. There was a consensus that the effectiveness of these actions currently represented probably the greatest uncertainty associated with the forecast. The Board identified the outlook for wage growth as another source of increased uncertainty. It was noted that the fall in oil prices might lead to lower growth in newly negotiated nominal wages via a fall in inflation. On the other hand, however, stronger wage growth might occur, as low oil prices imply lower corporate costs and hence higher operating profits. In the discussion about wages, it was also said that the wage growth assumed by the forecast for 2015 was over-optimistic and that this was weakening the inflationary effect of wages in the outlook.

In the discussion of uncertainties, it was said repeatedly that their transformation into anti-inflationary factors might give rise to a need to move the level of the exchange rate commitment. In this regard, it was said that monetary policy consisted primarily in influencing demand and that the uncertainties identified with regard to wage growth might in the outlook change into a factor having a negative effect on domestic demand. The uncertainties relating to the effectiveness of the ECB’s actions might foster continued importation of deflationary pressures over the forecast horizon. It was said that a monetary policy response would be necessary if a sustained downturn in aggregate nominal demand, demand-induced deflationary pressures and a substantial decrease in inflation expectations were to occur at the same time.

At the close of the meeting the Board decided unanimously to leave the two-week repo rate unchanged at 0.05%. Miroslav Singer, Mojmír Hampl, Kamil Janáček, Lubomír Lízal, Jiří Rusnok and Pavel Řežábek voted in favour of this decision. The Board also decided to continue using the exchange rate as an additional instrument for easing the monetary conditions and confirmed the CNB’s commitment to intervene in the foreign exchange market if needed to weaken the exchange rate so as to keep the exchange rate of the koruna close to CZK 27 to the euro.

 Author of the minutes: Michal Franta, Adviser to the Board