Minutes of the Bank Board Meeting on 31 August 2000

Present at the meeting: Josef Tošovský (Governor), Zdeněk Tůma (Vice-Governor), Oldřich Dědek (Vice-Governor), Miroslav Hrnčíř (Chief Executive Director), Luděk Niedermayer (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director)

The Board opened the meeting with an assessment of the newly available macroeconomic information and its relevance for expected net inflation developments. An analysis of the determinants of CPI components was used for the assessment. It was stressed that net inflation dynamics this year and for 2001 would be determined in different degrees by cost and demand factors. Assumptions on the intensity of the factors' impact over time were considered to be of key importance not only for quantifying the inflation forecast but also for identifying certain risks.

As a result of higher-than-expected price growth in past months, especially in the fuel and food segments, the net inflation estimate for the end of the year had been increased. After making this correction, the inflation forecast's midpoint is now aimed at the lower part of the inflation target band. Since the inflation forecast assumes that the inflationary impact of these items above the framework of the previous inflation forecast would die out by year-end, there was no change made in the net inflation estimate for the end of 2001. Current or predicted demand inflation - determined by wage developments - had shown no signs of acceleration, which would interfere with reaching the inflation target for this year or 2001. It was emphasised that adjusted inflation had been stabilised since August of last year, while experiencing no effects from rising fuel prices. This indicated the absence of demand-led inflation pressures during this period. In this respect, a view was expressed that the inflationary effect of rising fuel and food prices might be underestimated for next year if the secondary effect of rising fuel prices and increasing inflation expectations was not sufficiently reflected in the inflation forecast.

The Board analysed in detail the main factors that had caused the worsening trade deficit in 2000 Q2, as expressed in current prices. The deepening deficit was significantly affected by prices in the group of oil products. In this context, it was stated that rising prices in this group account for about 75% of the trade deficit's total increase in current prices. While assessing the effect of fuel prices on the external balance, attention was drawn to the possible short-term impact of deteriorating terms of trade on the current account balance. It was stressed that the fundamentals of foreign trade would be a determining factor in the longer run, especially foreign demand. Considering that the positive trade balance in the group of machinery and transport equipment was reduced to about half of last year's balance, one hypothesis suggested that increased investment demand in the area of machinery and technology also contributed to deterioration of the trade deficit. If this positive trend is confirmed, higher yields in the segments of domestic demand - especially fixed investment - could be expected for creating added value.

In the labour market, the unemployment rate rose in July. This rise was partially caused by seasonal factors as new graduates entered the labour market. However, there was also a certain increase in the seasonally adjusted unemployment rate. In this respect, it was pointed out that employment is a more appropriate indicator for evaluating the macroeconomic impact of the labour market on economic activity, because the unemployment rate is influenced by a variety of factors (e.g. demographics). Employment in companies with more than 20 employees continued to record a sharp decline as well as a reduction in the number of job positions in the manufacturing industry. A sample study also involving smaller companies provided a slightly more optimistic outlook - even in view of the lower prediction capabilities of this indicator. Overall, it was expressed that a sufficient number of job positions had still not been generated in the present stage of the economic cycle to halt the decline in employment.

During evaluation of expected demand factors, the Board said that preparations for the 2001 budget indicate the risk of a sharper rise in the structural deficit for public budget performance and a considerable amount of drawing on privatisation revenues. For this reason, it was stressed once again that the demand impact of public budgets must be assessed on a consolidated basis, while carefully accounting for revenue collections from privatisation and subsidies for transformation institutions.

The anticipated increase in the European Central Bank's short-term interest rates led to a discussion on the exchange rate's sensitivity to the interest rate differential vis-à-vis the euro. An opinion was expressed that even if ECB monetary policy had certain relevance for CNB policy, it would not be possible to mechanically react to interest rate changes in the Eurozone, because full coordination of economic cycles and sufficient convergence of relative prices had so far not taken place in all areas.

A significant amount of time was devoted to evaluating the risks that could potentially influence the inflation forecast for this year and 2001. During a discussion on the prices of oil products, it was mentioned that there were two realistic scenarios for expected development, however they would have different macroeconomic implications. According to the first scenario, there would be a decline in the level of oil prices after its initial acceleration. According to the second scenario, the price level would simply stabilise. Both scenarios could significantly affect future net inflation from the standpoint of year-on-year import price growth. It was also pointed out that, in view of the high volatility of food prices, it was difficult to assess the legitimacy of the assumption concerning the temporary character of the higher-than-expected inflationary impact of this segment of the consumer basket.

After reviewing the situational report, the Board decided unanimously to leave the CNB two-week repo rate at its current level.

Author of the Minutes: Tibor Hlédik, CNB, Council of Advisers

Comments are welcome on the following email address: Tibor.Hledik@cnb.cz