Minutes of the Bank Board Meeting on 30 November 2000

Present at the meeting: Oldřich Dědek (Vice-Governor), Zdeněk Tůma (Vice-Governor), Luděk Niedermayer (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director), Pavel Mertlík (Minister of Finance)

The Board opened the meeting with a discussion of the November situational report on monetary and economic development. It was expressed that the newly available information had not changed the current monetary assessment. In an environment of curbed demand pressures, the economy was now confronted with an external cost shock. After the effect of this year's high year-on-year rise in energy raw material prices had faded away, the central bank expected net inflation to stabilise in 2001 at a level consistent with next year's inflation target. The board members' view on the anticipated change in the structure of inflation had not changed. In addition, the cost factors of net inflation were expected to be gradually replaced by demand determinants.

In an assessment of the monetary and credit aggregates, the Board had not identified any specific information suggesting an incorrect monetary policy setting. Year-on-year M2 growth in October was 6.5%, which implied further slowing of the money supply's year-on-year dynamics. It was mentioned that no inconsistencies had been found when comparing year-on-year M2 growth with forecasted GDP growth in constant prices and the targeted year-on-year growth of the domestic price level. A view was expressed that the volatility of lending growth had been higher recently and that the decline in domestic lending would cease in the medium run. The forecast for next year presumes a slight recovery in domestic credit dynamics.

A part of the meeting was spent discussing the sudden strengthening of the koruna vis-à-vis the euro in the second half of October - i.e. from CZK 35.4 to 34.9. Thereafter, the exchange rate continued to appreciate to CZK 34.2. In this respect, the Board agreed with the transfer of funds acquired through the sale of the state share in Česká spořitelna for increasing the CNB's international reserves. The purpose of this transaction was to guard against the one-time rise in the volatility of the Czech koruna. During the discussion, it was stated that even though strengthening of the koruna had still been consistent with the inflation target and partially eliminated the inflationary impact of rising commodity prices on world markets, this appreciation meant tightening of monetary conditions in the current economic environment. From the standpoint of ensuring macroeconomic stability, tighter fiscal policy would be a more appropriate instrument.

It was expressed that the trade deficit in October had reached record values compared with the previous period. This deterioration signalled domestic demand acceleration in 2000 Q3. The main reason for this year's worse trade deficit in current prices continued to be the price effect of the rise in energy raw material prices. In Q3, however, the impact of changes in the physical volume of net export had started to increase. A structural analysis of the trade deficit in constant prices showed that the worsening trade deficit occurred mainly in chemicals, market products and machinery and transport equipment. Developments in the last two of these groups were related to ongoing investment activities. The negative net export balance in the chemical group can be attributed to continued restructuring and privatisation in the domestic chemical industry. The significance of the time lag between the demand effect of foreign direct investment and the production of new capacities in the economy was mentioned during a discussion on the medium-term sustainability of the current account deficit.

Wage developments were discussed on two levels: first of all, in view of the expected results of wage negotiations, and secondly, with respect to the impact of foreign direct investment inflow on wages. It was stressed that a key factor for the central bank was assuring that the rises in average nominal wages next year corresponded to realistic assumptions of future inflation and growth in national labour productivity. The CNB would put considerable emphasis on the objective presentation of its analyses during the upcoming meetings with trade union leaders, now held on a regular basis. The risk of future wage developments was also analysed in the light of higher dynamics and the absolute level of wages in foreign controlled companies - those most often receiving foreign investment - in comparison to other corporations. The Board focused its attention on the expected influence of the Balassa-Samuelson effect, ensuing from the different wage dynamics in sectors with varying labour productivity growth. It was expressed that the impact of foreign controlled companies on overall employment had still been relatively low, despite its share in employment increasing over the last two years from 4.5% to 7.8% (source: CSO). Therefore, it was expected that the risk stemming from the different level and dynamics of wages in the sector of highly productive foreign companies in comparison to other companies would be minimal only. Other factors affecting wage developments included the existing differences in the qualification structure of the labour force on the demand side in contrast to supply.

During the discussion on inflation expectations, it was expressed that never in the past had the inflation forecasts of market agents, the Ministry of Finance and the CSO, as well as the results of the CNB's survey, been so close to the central bank's inflation forecast.

In contrast to the last situational report, there was no over-assessment this time of the risk connected to any excess demand impulses from public finance performance in the context of continuing economic growth. Given the expected rise in the national debt next year, the Minister of Finance and board members discussed the issue of optimal national debt management in view of the financial system's smooth functioning and its impact on monetary policy. Due to increased government demand needed for securing national debt financing, there was a substantial rise in the slope of the yield curve.

The slight deterioration in external demand was indicated as a risk to future development. A wide range of indicators and new data pointed to a slowdown in economic activity for the Czech Republic's main business partners. The negative consequences of a possible slowdown in foreign demand would appear in the area of the external balance, though would, nevertheless, be positive in relation to the expected decline in import prices.

At the close of the meeting, members were invited to vote on the setting of monetary instruments. The Board decided unanimously to leave the CNB two-week repo rate at its current level (5.25%).

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

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