Minutes of the Bank Board Meeting on 29 March 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)

The Board opened the meeting with an assessment of the March situational report on economic and monetary development in the Czech Republic. Despite monthly deviations in both directions, the report confirmed, among other things, that inflation in the longer run was consistent with the forecasts. The external cost shock had been gradually fading, and food price inflation had stabilised at a year-on-year level of 3%-4%. The other components of net inflation had signalled the stability of price movements.

Under the influence of the CNB's last monetary policy measure, the yield curve had shifted downward for almost all maturities. Thus, the market had accepted the monetary policy action as an appropriate step. In the second half of March, the exchange rate temporarily appreciated. Soon after, though, there was a slight correction in the rate. In year-on-year terms, the nominal and real effective exchange rate had appreciated by approximately 3%.

During March, figures were published signalling faster economic growth. The gross domestic product increased in 2000 Q4 at a substantially faster rate than originally expected. The rise in stocks was a dominant factor on the demand side. The increase in final domestic demand was lower than anticipated. Household consumption was flat. Government consumption registered a decline, while fixed capital investment slightly increased.

Data on industrial and construction production for January 2001 also signalled favourable developments in the real economy. Although faster year-on-year wage growth in industry was recorded in January, it had so far only been assessed in CNB analyses as a temporary deviation. Moreover, labour productivity in industry had continued to increase at a faster pace than wages, ruling out any immediate threat of wage-cost inflationary pressures.

In the discussion to follow, board members agreed that there were no grounds for changing the assessment of inflation development for the upcoming period. Hence, they concentrated on some of the more general risks of the forecasts. Careful attention was paid to interpretation of the GDP data for 2000 Q4. Board members could not fully agree on how much emphasis to put on the fact that stock developments had stimulated economic growth on the demand side. One view expressed that growth stimulated by stocks was not a standard signal of a strong acceleration in recovery. On the other hand, some board members argued that an accumulation of stocks would reflect, in all likelihood, high future demand expectations from enterprises or ongoing structural changes in the economy, which would suggest, on the contrary, faster growth in 2001. Consequently, the Board decided to take up the discussion on GDP again at its April meeting when it had a more detailed analysis and an updated quarterly forecast of economic development.

The Board turned next to a discussion of the exchange rate. It was agreed that the recent strengthening of the exchange rate, though temporary, was not a welcome event. However, it was expressed that in the past few days the exchange rate had again corrected itself. There was consensus from board members that the central bank should not react to ordinary short-term volatility of the exchange rate, but that it should concentrate on eliminating the excessive exchange rate deviations that are more long-term in nature. In the longer term, market expectations associated with strong foreign capital inflow were causing the exchange rate to appreciate. These market expectations could, however, overestimate the effect of this capital inflow on the future exchange rate. One reason for this was that the CNB was still prepared to cooperate with the Government on eliminating the impact of large privatisation operations on the exchange rate using the "privatisation account".

The Board also carefully examined the risk of more substantial weakening of the business cycle in the European Union. A question was raised as to what degree Czech economic growth was reliant on export alone in the current phase of the cycle and to what degree it was affected by internal factors, especially investment. It was agreed that investment growth was encouraged by foreign capital inflow. One notion was that these investments were mainly motivated by demand for export. So if external demand weakened, then there could also be a slowdown in investment activity. Nevertheless, some members were of the opinion that the inflow of foreign investments was motivated more by longer-term convergence of the Czech economy with the European Union, and therefore it was not so closely connected to cyclical development. In addition, investment in the Czech Republic was apparently divided between the export production industries and the domestic market industries. Therefore, external development had so far not been assessed as an immediate risk, but only as a potential risk that the CNB would continue to monitor.

At the close of the meeting, the Board decided unanimously (with all seven members voting) to leave the CNB two-week repo rate at its current level.

Author of the Minutes: Tomáš Holub, Adviser to the Governor

Comments are welcome on the following email address: Tomas.Holub@cnb.cz