Minutes of the Bank Board Meeting on 31 May 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), Jiří Rusnok (Minister of Finance)

The May situational report on economic and monetary development confirmed that even the newly available figures would not call for any significant change in the CNB's assessment of the overall economic situation. The slightly higher-than-expected rise in food and fuel prices had not suggested a shift that would generate movement outside the targeted CPI-inflation interval. Moderate development in the unregulated prices of nontradable commodities was a positive indicator of price movement. As for external factors, high consumer inflation in Germany was considered to be an unfavourable indicator of future inflation. The M2 monetary aggregate had gained some momentum owing to an increase in net credit to the government and net foreign assets. However, the signs of a recovery in lending remained very weak. The year-on-year dynamics of the money supply (slightly above 9%) had not changed the CNB's expectations of anticipated economic growth or of achieving the inflation target, despite reaching the upper part of the M2 forecast.

The medium-term outlook for public finances was still disturbing. In addition, the report had pointed to some of the negative factors related to current developments - the relatively low dynamics of indirect tax collection, a possible rise in the general government budget deficits, and delayed privatisation income, which could interfere with the National Property Fund's financial performance.

Although the current account deficit had corresponded so far this year to CNB forecasts, real developments suggested that the annual results could be worse than originally expected. The deficits were no longer caused by rising world prices alone, but also by deterioration of real import and export. In the near future, the growth slowdown in Germany would have a negative effect on foreign demand.

Despite a rise in some of the inflation growth risks, the report concluded that a change in the setting of monetary policy instruments would not be needed.

In the discussion to follow, the Board emphasised that the deterioration of public finances along with the external balance (worsening of the "double deficit") was the main problem at this time. This type of situation would require optimal coordination of monetary and fiscal policy. The Board agreed that a priority instrument leading to renewed equilibrium was a government fiscal policy corresponding to the current economic cycle and the internal and external deficit tendencies. Isolated monetary policy measures were considered to be a sub-optimal solution.

Considerable attention was given to the trade and current account deficits and to possible analogies to the situation before the 1997 monetary crisis. Nevertheless, the favourable difference in the structure of resources was emphasised with respect to their role in financing the trade deficits. Another important factor was the floating exchange rate regime, which would offset the imbalance on the current account in the medium term. However, the Board also pointed out the danger to the stability of the economy if this balancing process were to occur in an abrupt fashion. Other risk factors were mentioned as well: the recent relatively strong outflow of portfolio capital, the high volatility of foreign direct investment inflow, expansive fiscal policy and, in turn, pressure on its financing, as well as any decline in the surplus inflow of long-term resources on the financial account in relation to the current account deficit.

In view of the inflation forecast risks, members also discussed the increase in wage growth, which could be another factor leading to a rise in inflation pressures during the forecast horizon.

Board members agreed that the current market expectations of further appreciation of the Czech koruna were largely based on the anticipated effect of new foreign investment related to privatisation. With the new minister of finance present at the meeting, agreement was once again confirmed on continuing the close cooperation between the CNB, the Ministry of Finance and the National Property Fund for using the NPF privatisation account to eliminate sharp rises in demand for the koruna.

There was consensus among the Board that developments in recent weeks and months meant a change in the monetary outlook. While in the past, uncertainties on various inflation developments had been evenly distributed, now the risks of an increase prevailed. However, these risks were not strong enough to require any immediate change in the setting of the monetary policy instruments.

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: Petr Krejčí, CNB, Adviser to the Governor

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