Repo rate cut, approvement of the Inflation Report

At its meeting today, the CNB Board decided to cut the 2W repo rate from the present 6.5% to 6.25%, effective 30 July 1999.

The CNB Board also approved the sixth Inflation Report covering the 1999 Q2 period. In the summary of this report, the following is stated:

In 1999 Q2, the fall in year-on-year inflation continued. However, after a more significant drop in previous quarters, the decline slowed considerably and inflation gradually stabilised at low levels. This characterises the course of both net inflation - whose outturns were negative in Q2 - and the consumer price index. According to the outlook for the end of 1999 and for 2000, inflation will gradually edge up. However, it should develop in line with the medium-run inflation target for 2000.

The decline in inflation in Q2 was fostered by the ongoing fall in net inflation and the slowdown in regulated price adjustments. The two components of net inflation developed differently. Food prices continued to fall relatively fast. Conversely, adjusted inflation rose moderately, thus curbing the price decline.

In Q2, prices were affected by the longer-term contraction of both domestic and foreign demand, which started as early as in 1997 and continued into the beginning of 1999. Food prices, which have contributed most to the decline in inflation in recent quarters, were affected by subsidised food imports from EU countries, relative domestic over-production and also by significant changes in the retail market structure.

In the shorter run, the slower rate of price index decline in Q2 was fostered by rising prices of raw materials and energy sources as well as by the koruna's depreciation vis-ŕ-vis the main world currencies in Q1. However, the effect of the depreciation on prices turned out to be less strong than was expected by the CNB. This was because the ongoing economic recession prevented cost inflationary pressures from being felt fully. Expectations that under conditions of increasing capital inflow the exchange rate depreciation would not be a lasting tendency but only a temporary fluctuation may also have played a role, too.

In Q1, the year-on-year decline in GDP further intensified. This was caused by a considerable deterioration of net exports and a contraction in gross fixed capital formation. A slight rise in household and government consumption counteracted the fall in GDP.

The worsening of net exports was generated in particular by a fall in exports to transition economies, which reflected the contraction of economic activity in these countries. The decline in investment activity corresponds with the cyclical development of the economy - the investment is of a strongly pro-cyclical nature.

However, structural changes in the economy, where capital-intensive industries are declining in significance, may be reflected in a longer-term fall in investment growth and a reduction in the investment rate.

Growing real household incomes fed through into household consumption. However, the consumption and saving behaviour of households was affected by the increasing unemployment rate and by uncertainties about any possible future turnaround of the economy. These factors will continue to act in the forthcoming period, and so it is possible to expect only a slow rise in consumption and a moderate economic revival by the end 1999.

This macroeconomic trend will continue to subdue the cost-push price pressures generated by the current growth in wage costs and by the rise in import prices connected with commodity price developments on global markets. Cost-push inflationary pressures will decrease in the longer-term horizon, mainly in connection with productivity growth. Owing to ongoing long-term restructuring, the economic upturn will be accompanied by a rise in unemployment.

The money supply growth rate picked up at the beginning of 1999, and the higher year-on-year increases continued into Q2. The growth in the money supply is linked with the rising inflow of foreign capital. The growth rate of domestic credit supply remains subdued.

In Q2, the CNB´s monetary policy was based on an assessment of macroeconomic developments and of the effect of inflation factors on future price development. The centre of focus was gradually shifted to price development during 2000 and its consistency with the net inflation target for the end of 2000. Monetary policy was also based on the expected inflow of capital into the economy and the effect of this on the exchange rate. It also responded to changes in foreign interest rates, particularly the April interest rate cut by the European Central Bank.

The inflation prognosis up to the end of 2000 (when even though price indices should be rather higher than in 1999 Q2, net inflation will nevertheless be moving in the lower half of the inflation target interval) facilitated a further moderate correction of interest rates. In the monitored period, the CNB cut the 2W repo rate in three steps by a total of 1 percentage point to 6.5%.

CNB - Public relations division