Minutes of the Board Meeting on 28 November 2002

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 a presentation of the 11th situational report. The main focus of the presentation was on assessing the importance of the new monetary-relevant data for the balance of risks relating to the October medium-term inflation forecast.

In October, prices in the main price groups were situated slightly below the prediction. Year-on-year CPI growth registered 0.6% in October. The difference in relation to the forecast was caused by a higher-than-expected decline in food prices. Year-on-year growth in industrial producer prices was slightly lower than the CNB's prediction. This was mainly the result of a lower-than-expected rise in the prices of electricity and selected energy raw materials. A year-on-year decline in agricultural producer prices of -10.6% had a strong anti-inflationary effect in October as well.

The year-on-year dynamics of M2 in September remained relatively low at 4.8%. Credit growth was almost entirely concentrated in the area of consumer loans and mortgages. Year-on-year industrial production growth of 9.2% (4.5% after adjusting for the higher number of working days) along with high sales dynamics for industrial production in September compensated for less favourable data from previous months. In the area of domestic demand, figures were released for retail trade turnover in September and sales of services for Q3. In September, the relatively high growth of retail sales in constant prices was affected to a large extent by the two extra business days and demand related to the August floods. The negative effects of the floods were apparent even in sales of services, which declined by -0.4% y-o-y. Weakening domestic and foreign demand was also reflected in the seasonally adjusted unemployment rate, which continued to rise. In the area of the exchange rate, the Czech koruna weakened at a gradual pace during October vis-à-vis the euro.

During the presentation of the situational report, special attention was given to interpreting the foreign trade figures for September and October. The balance of trade deficit in current and constant prices was significantly higher in both months than the CNB's prediction. In this respect, the specific factors behind the balance of trade deficit and their contribution to the overall worsening of the deficit were analysed. These included, in particular, the real exchange rate, foreign and domestic demand and any transient factors. It was mentioned that the relative contribution of these factors to substantial deterioration of the external imbalance was still difficult to identify in view of the short history of data affected by passing events and the possible combined effect of all of these factors.

For October and the first half of November, information in the area of the external environment did not significantly deviate from the assumptions in the October medium-term forecast. In November, Germany's economic growth estimate for 2002 was reduced slightly by 0.2 percentage points to 1.3%. The average October price of Ural oil remained approximately at the same level as the forecast for 2002 Q4. However, a tendency towards a sharp decline in oil prices of about 4 USD/barrel had been evident on world markets since the beginning of October.

In the discussion to follow, the board members identified the main economic areas that had undergone significant changes in order to assess a possible shift in the risks of the October inflation forecast.

One of the main points discussed was the worsening balance of trade deficit during recent months. It was said that a more pronounced decline in the balance of trade deficit in constant prices had so far occurred only in September and October. However, a worsening trend had been observed since the end of the second quarter. Although board members ascribed different levels of intensity to the specific factors of foreign trade, there was consensus on the fact that the recent sharp deterioration in the balance of trade deepened the conflict related to restoring the external and internal balance. The Czech Republic is a small, open economy with a floating exchange rate, and consequently, monetary policy decision-making must inevitably deal with keeping the balance of trade deficit at a financeable level.

The Board agreed that exchange rate expectations would shift in the direction of depreciation due to the worsening balance of trade, the likely decline in the balance of services of the balance of payments and postponement of some privatisation decisions.

The board members described the overall monetary and macroeconomic situation as a low-inflation environment. Under the assumption of achieving the inflation forecast, CPI inflation would stay below the lower band of the inflation target over the next several quarters. In this respect, one view expressed that there were several explanations for the restrained level of inflation pressures. Besides the restrictive influence of a strengthening real exchange rate and low foreign demand dynamics this year, it was also impossible to ignore the impact of the growth rate for regulated prices and indirect taxes, which was lower than initially expected when setting the inflation target. The sharp year-on-year decline in food prices - generally very volatile in nature and often not affected directly by monetary policy over the short run - also helped reduce inflation pressures. Another view pointed to the risk that inflation would move below the lower boundary of the targeted band for a longer period of time than predicted by the actual forecast due primarily to lower-than-expected price growth abroad.

Similarly as in last month's discussion of the situational report, this time the Board also identified as one of the most serious risks the uncertainty surrounding the size and timing of the demand effect of fiscal policy. Members, therefore, pointed to the higher likelihood that a part of the planned fiscal expenditures for this year would shift over to next year, according to available information. This uncertainty complicated the setting of monetary policy in two ways. First of all, the size of the expected demand impulse relating to public finance performance for next year was not known. Secondly, the main factors of economic growth this year would be difficult to quantify.

Following the discussion of the November situational report, the Board decided by a majority vote to leave the CNB two-week repo rate at its current level. Six members were in favour of this decision, and one member voted to reduce interest rates by 0.25 percentage points.

Author of the Minutes: Tibor Hlédik, Adviser to the Board