Minutes of the Board Meeting on 25 January 2001

Present at the meeting: Zdeněk Tůma (Governor), Oldřich Dědek (Vice-Governor), Luděk Niedermayer (Vice-Governor), Michaela Erbenová (Chief Executive Director), Jan Frait (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director), Pavel Mertlík (Deputy Prime Minister and Minister of Finance)

The Board opened the meeting with an assessment of the situational report on economic and monetary development in the Czech Republic. The report indicated, among other things, that the primary effects of the external cost shock - evoked by previous world price developments in energy raw materials - had faded away at the end of last year sooner than anticipated. Strengthening of the koruna was the second factor causing the net inflation index at the end of 2000 to be below the limit of the medium-term target. Revaluation of external monetary factors and expected food prices caused a slight downward shift in the inflation forecast. The forecast was anticipating this year's December net inflation to be in an interval of 1.7% to 3.4% and the consumer price index in a range of 3.6% to 4.8%. The first price forecast for 2002 was also reviewed at the board meeting. Maintaining the current monetary settings during slow economic growth recovery - causing, in turn, the production gap to gradually narrow - would lead to an increase in net inflation to values between 2.3% and 4.1%.

Board members thereafter evaluated the risks associated with the forecasts. They agreed that this year's inflation would most likely be situated in the lower half of the targeted interval. It was stressed that the risk of not reaching the forecasts was mainly ascribed to possible inconsistencies in the koruna exchange rate, import prices, world economic developments and the ambiguous outlook for public finances in 2002. Some board members expressed doubts as to whether or not there would be an increase in inflation as implied by the 2002 forecast.

A considerable amount of time was spent during the meeting discussing the issue as to whether an appropriate response to lowering the inflation forecast's midpoint by 0.3 points would be to immediately lower interest rates in context with inflation targeting. A general conclusion reached from the discussion was that the forecast's conformity with the targeted interval and the CNB's long-term efforts to anchor stable inflation expectations were the main reasons for leaving interest rates at their current level. According to CNB analyses, import prices, in contrast to the previous period, would be expected to have a slight anti-inflationary character in 2001. Given this assumption, a forecast heading towards the lower part of the targeted interval could be considered consistent with the inflation-targeting regime.

Members also discussed the unfavourable developments in time deposits where steadily declining real interest rates had changed into negative values. Moreover, the Board stressed that the inflation forecast was consistent only under the assumption that demand would slightly increase, as derived from the 2001 economic growth forecast of 1.7% to 3.7%. The risks of this estimate were connected to the positive structural changes perhaps not being sufficiently reflected on the supply side.

In this respect, members examined the persistently low dynamics of credits and the sensitivity of credit growth to an eventual cut in interest rates. In assessing unfavourable lending developments, the Board considered the non-standard situation of the largest banks to be especially relevant. These banks were either entering the pre-privatisation phase, adopting the more demanding lending criteria of new foreign owners or were going through the essential process of cleaning up their credit portfolios. Since the existing level of nominal and real interest rates had been low, this development reflected a continual lack of viable, creditworthy projects and the fact that the structure of bank supply in some cases had not met corporate demand for loans. Under these conditions, it would not be realistic to expect an interest rate cut to affect lending in a more discerning manner. As a reminder, it was mentioned again that economic conditions had been significantly relaxed by expansive developments in the area of public finances.

The discussion also focused on the setting of the discount and Lombard rates. The Board agreed that rates allowing symmetrical movement of the base interest rate in both directions would better correspond to the conditions of stable inflation. However, there were concerns that isolated cuts in the discount rate or the Lombard rate could be wrongly interpreted by markets as a clear signal of a rate decline trend in the future. The Board would take up these issues again in some of their future meetings.

At the close of the meeting, the Board decided unanimously to leave the CNB two-week repo rate at its current level. Members also ruled not to change the setting of the discount rate or the Lombard rate.

Author of the Minutes: Petr Krejčí, Adviser to the Governor

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