Minutes of the Board Meeting on 26 September 2002

Present at the meeting: Zdeněk Tůma (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 a presentation of the 9th situational report on economic and monetary development. It was stated that current consumer prices, which had increased 0.6% year-on-year in August, corresponded to the CNB's inflation forecast. There was a more substantial drop in food prices, though, some services did register growth. The prices of these services were affected by the decisions of relevant regulatory institutions. Industrial producer prices in August showed a year-on-year decline of 0.9%, and disinflation for agricultural producers was even stronger.

The GDP data for Q2 also corresponded to the CNB's forecast. Although the Czech Statistical Office had allowed more uncertainty in their estimates than usual, the figures on year-on-year dynamics could indicate a certain slowdown in economic growth due primarily to weak foreign demand and exchange rate developments. Despite considerable fluctuation in monthly industrial production data, overall growth for this year had so far been satisfactory, i.e. +5.3%. However, these figures were for the first seven months, and a slowdown could be expected in August due to the severe flooding in the Czech Republic. This situation also applied to the dynamics of retail sales, which rose January to June by 3.8%.

In recent months, the rate of money supply growth had slowed. In July, M2 increased by 4.4% year-on-year. The August estimate showed a slightly higher figure. These data corresponded to exceptionally low inflation and to slowing economic activity. Longer money-market interest rates revealed a declining trend. The inverted shape of the yield curve (up to 1Y maturity) could reflect the behaviour of some market participants, who admitted the possibility of another reduction in the CNB's repo rate.

The average EUR exchange rate in Q3 had thus far reached CZK 30.18. Overall, the current account deficit (3.5% of GDP) registered a substantial year-on-year improvement, despite worsening balances for incomes and services.

The situational report examined the risks of the last quarterly macroeconomic forecast. World oil prices were considered to be the main risk involved in achieving the forecast. Within a short period of time, the average price of Ural oil could be expected to move at least 10% above the current estimates. The second pro-inflationary risk was related to uncertainty about the character of the final flood-repair resolution and its effect on demand and prices. The nature of disinflationary risks remained unchanged from the last situational report. The effects of weak foreign demand and low inflation (related mainly to Germany) were still seen to be the main risk.

In the discussion to follow, board members agreed that pro-inflationary and anti-inflationary risks seemed to be more balanced than during the last discussion on the situational report. The difference was that disinflationary pressures on the whole could be reliably identified - in particular continuation of a sluggish economic recovery in Europe. Nonetheless, there were serious uncertainties generated by political factors at home and abroad. This mainly involved the outcome of the Middle East crisis, the likelihood of approval as well as the content of tax legislation and other government regulatory measures proposed for dealing with flood damages and the state of public finance.

In the discussion on monetary policy decision-making, one view expressed that internal inflationary pressures did not exist at this time and that the July inflation forecast had been achieved. The anticipation of low-inflationary developments was further supported by information on world economic perspectives.

On the contrary, it was said that the reduction in rates along with a stabilised exchange rate had caused monetary policy to ease up somewhat in relation to the forecast. Members also pointed to the dominant pro-inflationary character of growing uncertainties, especially in the area of cost-push inflation. As for public finance, data would be available in the near future that could alleviate some of the pending uncertainties - in particular, the budget proposal for 2003 and the medium-term fiscal outlook.

Doubts were expressed about whether a small interest rate reduction could at this time move the economy towards potential growth and cause inflation to return more quickly to the targeted band. However, it was reminded that the current price indices showed characteristic development in that there was a reverse in all price segments according to the forecast and that the effect of an additional monetary impulse could be uncertain in such a situation.

Board members agreed once again that the current koruna exchange rate did not correspond to economic fundamentals. In this respect, the Board discussed the CNB´s approach to foreign exchange intervention.

Following the discussion on the situational report, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged. Five members voted in favour of the decision, and one member voted for cutting interest rates by 0.25 percentage points.

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

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