Česká národní banka

Minutes of the Bank Board Meeting on 3 May 2018

Present at the meeting: Jiří Rusnok, Mojmír Hampl, Vladimír Tomšík, Vojtěch Benda, Oldřich Dědek, Marek Mora, Tomáš Nidetzký.

The meeting opened with a presentation of the third situation report and the new macroeconomic forecast covering the horizon up to the end of 2019. Headline inflation had gone down to 1.7% in March. Its decline slightly below the target had primarily reflected the fade-out of last year’s one-off factors and a fall in import prices. The Czech economy was above its potential output level. Household consumption remained a stable basis for GDP growth, reflecting strong income growth and optimistic expectations. Growth in economic activity was also being significantly aided by an increase in investment in the private sector and recently also in the government sector.

According to the new forecast, inflation would stay slightly below the target this year. On the one hand, domestic inflation pressures would remain strong but would gradually ease. On the other hand, the anti-inflationary effect of import prices, reflecting the strengthening koruna, would gradually weaken. Inflation would thus return very close to the 2% target at the monetary policy horizon. The growth of the Czech economy would slow from last year’s high pace, but would remain above 3%. GDP growth would be driven by continued brisk growth in household consumption and private and government investment. The unemployment rate was at a record low and there was little room for it to decrease further. Employment growth would therefore slow, whereas wage growth would remain high.

Consistent with the forecast was broad stability of market interest rates initially, followed by gradual growth in rates in the direction towards their long-run neutral level from late 2018/early 2019. Continued accommodative monetary policy of the European Central Bank would remain a barrier to a faster increase in domestic interest rates. According to the forecast, the koruna would appreciate further, owing among other things to a positive interest rate differential vis-à-vis the euro area. Solid growth in external demand and real convergence of the Czech economy to euro area countries would also act in this direction. Next year, the koruna would appreciate much more modestly due to slowing growth in external demand and the European Central Bank’s expected return to conventional monetary policy.

In the discussion that followed the presentation of the situation report, the Board assessed the risks to the new inflation forecast at the monetary policy horizon as being balanced. An opinion was expressed that the risks to the forecast were slightly inflationary. However, an opinion was also expressed that the risk to the forecast was slightly anti-inflationary, due mainly to developments in the external environment. The main uncertainty stemmed from the strength and composition of the domestic inflation pressures, the second uncertainty remained the exchange rate path and the third uncertainty was connected with developments abroad.

As regards domestic price developments, there was a consensus that the economy was facing inflation pressures stemming from the positive output gap and the tight labour market. They were being balanced by the strengthening exchange rate and continued subdued growth in foreign prices. Another inflation-reducing factor was growth in labour efficiency linked with persisting growth in private investment, the scale of which was discussed. On the one hand, the opinion was expressed that labour efficiency in the Czech economy was rising swiftly and would continue to do so, as signalled, for example, by observed growth in fixed investment in non-financial corporations. Long-standing labour market tightness, manifesting itself in increasing wage costs and a shortage of skilled labour, would lead to further substitution of labour by capital. Thanks to new technology, this could happen in many sectors of the economy. The opinion was also expressed that firms in the Czech Republic had been forced to raise their competitiveness in the post-crisis period of low growth and were thus now far more efficient. On the other hand, given the observed decline in firms’ profitability, doubts were expressed about the positive labour efficiency trend. According to this hypothesis, firms were facing higher wage costs and – in an environment of strong competition where they were unable to increase the prices of their output – their profit margins were falling in the absence of efficiency growth. In connection with the falling profitability of firms, the opinion was also expressed that in the Czech environment, where wage bargaining is predominantly decentralised, wage growth might gradually slow to maintain profit margins. On the other hand, it was observed – on the basis of historical data – that wage growth in the Czech economy had typically slowed substantially only when a recession or crisis had started.

The board members also discussed the current exchange rate of the koruna against the euro, which at the time of the meeting was weaker than forecasted. They agreed that the average deviation from the baseline scenario of the forecast was currently small and not alarming in a floating exchange rate regime. However, the opinion was also expressed that an extended period of a weaker exchange rate could represent a slight upside risk to inflation. A weaker exchange rate for an extended period would thus make it possible to tighten the monetary conditions through the interest rate channel rather earlier than assumed by the forecast.

As regards a possible earlier rate increase compared with the new forecast, the opinion was also expressed that the present situation offered room for such action. This was because the economy had been operating above its potential output level for some time and would continue to do so according to the outlook. Client rates in the economy were meanwhile lower than when the CNB had reduced its rates to technical zero. According to this opinion, an immediate increase in key rates would additionally complement the previously adopted macroprudential policy measures targeted at cooling the residential property market. However, several board members countered this opinion by arguing that an immediate increase in monetary policy rates would not be consistent with the current flexible inflation-targeting framework. This was because the basis for decision-making and transparent communication in that regime is the forecast, which currently expected inflation to return to the target from below and interest rates to go up in several quarters’ time. This step would be hard to defend in the current monetary policy regime. Regarding the complementary effect of an increase in monetary policy rates on financial stability, there was a consensus that the direction of monetary policy was the same as that of macroprudential policy, hence the future increase in rates assumed by the forecast would support financial stability. A majority of the board members meanwhile agreed that the macroprudential policy measures adopted were working and there was no need to complement them with an immediate hike in monetary policy rates. The opinion was also expressed that given the incomplete transmission of money market rates to client mortgage rates, targeted financial stability instruments could be more effective in suppressing the risks arising from the residential property market than an increase in key rates.

The board members went on to discuss the risks arising from current developments abroad. They agreed it was premature to assess the weaker figures from the euro area as a change in trend. Some slowdown in euro area growth was expected in the forecast. On the other hand, the pace of that slowdown was an uncertainty that had implications not only for demand for Czech exports, but also for the speed of return of ECB monetary policy to a neutral stance and hence for the market interest rate differential between the Czech Republic and the euro area. Concerning the growing tendencies towards protectionism, it was said that their impact would depend on their duration and extent, in other words on characteristics that were unknown at present.

At the close of the meeting the Board decided to leave interest rates unchanged. The two-week repo rate remains at 0.75%, the discount rate at 0.05% and the Lombard rate at 1.50%. Jiří Rusnok, Vladimír Tomšík, Vojtěch Benda, Oldřich Dědek, Marek Mora and Tomáš Nidetzký voted in favour of this decision. Mojmír Hampl voted for increasing the repo rate by 25 basis points and the Lombard rate by 50 basis points.

Author of the minutes: Tomáš Adam, Monetary Department