Česká národní banka

CNB > Monetary policy > CNB Board decisions > 2019 > 7 February 2019

Minutes of the Bank Board Meeting on 7 February 2019

Present at the meeting: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda, Oldřich Dědek, Tomáš Holub, Aleš Michl.

The meeting opened with a presentation of the first situation report and the new macroeconomic forecast covering the horizon up to the end of 2020. Headline inflation had declined to 2% in 2018 Q4, owing mainly to smaller contributions from food and fuel prices. The inflationary effect of import prices had also weakened. The domestic inflation pressures stemming from buoyant wage growth and continued economic growth nonetheless remained strong. The Czech economy was still operating above its potential, while the positive output gap was gradually closing.

Inflation would rise temporarily at the start of this year and would return to the CNB’s 2% target in the course of the year and stay very close to it over the monetary policy horizon, i.e. in the first half of 2020. The persisting substantial domestic inflation pressures would be counteracted by an increasing anti-inflationary effect of import prices resulting from a fall in inflation abroad and renewed appreciation of the koruna. The previous interest rate increases would also help the inflation target to be achieved at the start of next year. Growth of the Czech economy of around 3% this year and the next would be consistent with the long-run equilibrium growth rate. GDP growth would be driven mainly by household consumption and also by private and government investment. The unemployment rate was at a record low and there was little room for it to decrease further. This would lead to slower employment growth and still high, albeit gradually moderating, wage growth.

Consistent with the forecast was broad interest rate stability. Upward pressure was being exerted on rates primarily by the currently weakened koruna, which was dampening the anti-inflationary effect of import prices. The strong domestic inflation pressures and the gradual pass-through of the higher administered price inflation into other components of inflation were acting in the same direction. Renewed appreciation of the koruna amid persisting negative interest rates in the euro area until the end of 2020 would subsequently have the opposite effect on rates.

In the discussion that followed the presentation of the situation report, a majority of the board members assessed the risks to the forecast as being slightly inflationary and tilted towards slightly higher interest rates compared to the forecast. A potential weaker exchange rate of the koruna in the course of this year compared to the forecast was a risk in this direction. Other risks and uncertainties stemmed from external developments, where the balance had tilted to the downside. A major risk was a disorderly Brexit, which could lead to a marked slowdown of the Czech economy and also to a weakening of the koruna. The risk of a slowdown trend in China and the impact of such a slowdown on the global economy also represented a risk. The impacts of protectionist measures in global trade remained a source of external uncertainty. For these reasons, some of the board members assessed the risks to the inflation forecast as balanced. Related to the growth of the Czech economy, some of the board members simultaneously viewed the new forecast as moderately optimistic.

The majority of the Board agreed that the monetary policy of the Czech National Bank was in an interest rate normalisation phase. However, unfavourable data coming in from the external environment was increasing the uncertainty regarding further growth in domestic interest rates. In this regard, the opinion was expressed that monetary policy interest rates might not reach their neutral level at all in the current phase of the cycle. A majority of the board members also agreed that the potential delay risk associated with leaving interest rates unchanged in February was small, as rates could be raised at one of the next monetary policy meetings. On the other hand, the opinion was expressed that main reasons for increasing rates, namely the exhausted labour market and evolution of the koruna’s exchange rate, still applied, so developments abroad were no reason for putting off a rate increase. It was also said that given the current and neutral interest rate level, one more increase in rates did not constitute monetary restriction, but only a softening of the still expansionary effect of monetary policy.

The Board went on to discuss the exchange rate. It was said that given the adverse global sentiment and regional factors, and also given the koruna investment positions that had been created during the exchange rate commitment, the Czech currency was not strengthening. The opinion was expressed that the exchange rate might reflect fundamental changes on foreign exchange markets and the koruna appreciation trend observed in the pre-crisis period might not be renewed. In such case, the exchange rate would therefore not counteract domestic inflation pressures as it had in the past. This would necessitate a stronger response in the interest rate component of the monetary conditions. In connection with the exchange rate of the koruna, concern was also expressed about the published forecast-consistent exchange rate and interest rate paths losing credibility as a guide for the financial markets regarding the settings of monetary policy instruments. This concern stemmed above all from a repeat of the situation of rates being left unchanged while the exchange rate was weaker than in the previous forecast. Against this argument, it was noted that the Czech National Bank targets inflation, not the exchange rate or interest rates, and the forecast had to be considered as a whole. The new forecast reflected a range of new assumptions, especially about the external environment. According to this opinion, it would be very simplistic to derive implications for the movement of interest rates purely on the basis of the fulfilment of the exchange rate forecast. It was mentioned repeatedly in the discussion that in a small open economy the exchange rate acts as a stabiliser and can thus counterbalance the anti-inflationary pressures stemming from reduced demand in the event of a global downswing.

A large part of the meeting was devoted to developments abroad. The Board discussed a disorderly Brexit sensitivity scenario in which the UK leaves the EU without a withdrawal agreement. There was a consensus that in terms of its impacts on the Czech economy via the trade channel, this would represent a shock causing economic growth to slow and the koruna to weaken. Together with the introduction of tariffs in trade with the UK and the disruption of some global production chains, the weaker exchange rate would have an inflationary effect via higher import prices. The cooling of the domestic economy would conversely have an anti-inflationary effect. However, the overall monetary policy implications of a disorderly Brexit, i.e. whether the inflationary or anti-inflationary effect would prevail, would depend on many other factors that could not be fully quantified at present. The monetary policy response would thus probably be decided only after all the relevant factors had been assessed.

The other external factors discussed included developments in the euro area and Germany, where incoming indicators had been signalling a slowdown in recent months. The Board considered whether this slowdown was due to temporary factors, especially in Germany, or whether it was a trend that might continue. The economic downturn in the Czech Republic’s largest export market was also put into context with the situation in China, where economic growth has long been slowing but the extent and causes of the slowdown are the subject of considerable uncertainty. The opinion was repeatedly expressed that the downswing in external demand might have a stronger downward effect on domestic wage growth. On the other hand, the opinion was expressed that the slowdown of the European economy could be due to supply-side factors, specifically the exhaustion of spare production capacity.

The relationship between monetary and macroprudential policy was also mentioned. The Board agreed that both policies of the central bank had been heading in the same direction recently. Targeted financial stability instruments were more effective at suppressing the risks stemming from developments on the residential property market, and the data indicated that they were effective. It was also said that monetary policy instruments affect the performance of the real economy as a whole. It was noted that a sound economy and labour market are a prerequisite for a stable financial system.

At the close of the meeting the Board decided by a majority vote to leave the two-week repo rate unchanged at 1.75%. Five members voted in favour of this decision: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Oldřich Dědek and Tomáš Holub. Two members voted for increasing the rate by 0.25 percentage points: Vojtěch Benda and Aleš Michl.

Author of the minutes: Tomáš Adam, Monetary Department