Minutes of the Board Meeting on 11 July 2002

Present at the meeting: Zdeněk Tůma (Governor), Oldřich Dědek (Vice-Governor), Luděk Niedermayer (Vice-Governor), Michaela Erbenová (Chief Executive Director), Pavel Štěpánek (Chief Executive Director)

Due to the sharp appreciation of the Czech koruna over the past few days, the CNB Board exceptionally devoted its regular weekly meeting to monetary policy issues. The Board opened the meeting with an assessment of current economic developments, and in particular, to the risks associated with koruna appreciation. With the koruna appreciating at a faster pace, the board members discussed whether or not postponing any decision-making until the next regular monetary policy meeting would expose the economy to the negative effects of a strong koruna. Two alternative reactions to the existing exchange rate fluctuation were, therefore, analysed.

The first alternative considered was an immediate response to the situation. It was stated that strong, temporary fluctuations in the exchange rate could be costly for the economy if it resulted in the loss of production capacity. Furthermore, it was mentioned that the available aggregate data did not reflect the potential negative impact of a strong currency. Some figures, however, were already sending clear signals, and a quick response from the central bank could soften the negative impact.

In this respect, the Board discussed the role the exchange rate would have in its inflation-targeting strategy. It was expressed repeatedly that a discussion on the exchange rate did not imply in any way that the inflation target's role had been reduced. In view of the economy's openness, stronger exchange rate fluctuations inevitably had an effect on the aggregate economic variables, including inflation. It was said that current exchange rate developments clearly showed that one of the fundamental inflation-forecast assumptions would be corrected in July, and for this reason, a monetary policy response should be considered. Foreign exchange intervention was seen, in this context, as a legitimate monetary policy instrument whose success depended on the efficiency of the market.

The second alternative was to postpone any monetary decisions until the next regular monetary policy meeting. It was mentioned that the new quarterly forecast on economic development would be available at this meeting, and disclosing this information could increase the effectiveness of the adopted measures. A view also expressed that intervention might not be totally adequate if not accompanied by a reduction in rates and if not a part of a more comprehensive strategy.

There was consensus among board members that the strong currency was such a serious problem that the central bank's monetary policy instruments could not cope with the situation alone. A valuable role was also played by the Government's cooperation in sterilising the impact of privatisation income and additional inflows of foreign currency revenue. However, exchange rate developments were also closely connected to fiscal policy settings. Closer coordination of economic policies was therefore desired, especially in respect to exchange rate development.

By a vote of four to one, the Board decided to leave the CNB two-week repo rate at its current level. One member of the Board was in favour of reducing rates by 0.5 percentage points. In addition, the Board decided to intervene on the foreign exchange market according to the existing conditions.

Author of the Minutes: Kateřina Šmídková, CNB, Adviser to the Board

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