Minutes of the Board Meeting on 16 July 1998

At its meeting on 16 July 1998, the CNB Board assessed the new inflation data and the results of the analyses that had been requested by the Board at its meeting on 2 July 1998. The Board stated that net inflation development was in compliance with the inflation targets. At the end of 1998, net inflation is likely to be in the lower part of the target interval. This would create a favourable position for the achievement of the medium-term target.

The Board opened the meeting by reviewing the latest information on the exchange rate development. The situation on the foreign exchange market was affected by the CNB foreign exchange interventions on Tuesday, 14 July 1998, which probably prevented a further shift in the exchange rate. In this context, several views were expressed about the exchange rate issues. The status of the Czech koruna on financial markets is a very significant factor of exchange rate development. Given the present stage of convertibility, the koruna exchange rate is mainly defined by financial account movements, while the current account affects the exchange rate primarily in cases of more substantial trade disequilibrium and often with a certain time lag.

Although the calming of the situation in Russia has stabilised the situation on financial markets, exchange rate corrections could still be possible in case of the activation of this external factor. Most of the Board members stressed that the latest exchange rate development was not a reason for considering cuts in interest rates and that the exchange rate would not be directly affected by the monetary policy measures. It was mentioned that the Lombard and discount rates might be reviewed in the future.

The effects of monetary policy were the main topic of discussion. Specification of the new government's fiscal and economic policies in the forthcoming two years has been very difficult up to now. This has been reflected in the increased uncertainty faced by the CNB in evaluating the impact of monetary policy measures. It was stated that this posed a serious problem since the weight of monetary transmission was presumably relatively lower in the short run than the weight of fiscal transmission. The formation of inflation expectations and their influence on investment decisions and the saving ratio were identified as an important transmission mechanism of monetary policy. A hypothesis was put forward that cost inflation factors, particularly interest rates, would prevail over the influence of subdued demand. The opinion prevailed that in the Czech economy, the problem consists more in the existence of a certain time lag between contraction of domestic demand and a slowdown in inflation. The opinion that
interest rates were a significant cost factor was rejected by the majority of Board members as empirically unfounded, based on the analysis of submitted data.

The CNB Board decided unanimously to cut its two-week repo rate from 15% to 14.5%, effective 17 July 1998. The change in the interest rate reflected the change in the economic situation which was characterised by a lower risk premium and a fall in inflation expectations. The Board assumed that, under the given conditions, the newly set interest rate level was in accord with the achievement of the CNB's medium-term inflation target as well as the target for this year. Further monetary policy measures could be adopted after an analysis of the impact of the July price corrections. If the positive economic trends were to continue, the CNB would be ready to respond adequately. Should the present favourable external conditions significantly worsen or should a more principal change in fiscal policy occur, further tightening of monetary policy would be required.