Minutes of the Board Meeting on 19 December 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 discussed the December situational report assessing the new information released since the discussion of the November situational report. The current data on inflation were lower in comparison with the October forecast. Consumer prices in November rose year-on-year by 0.5%, which was 0.4 percentage points less than predicted by the forecast. A slight price decline in most segments of the consumer basket was the reason behind this development. Domestic demand had increased faster and foreign demand slower than the forecast's assumptions.

Foreign demand growth forecasts were adjusted downward by 0.6 percentage points. The cost factors of inflation were anti-inflationary in nature. Industrial and agricultural producer prices were declining. According to the newly available GDP figures, domestic demand was supported in particular by private consumption. Household demand rose at a rate of 5.3%, 1.1 percentage points more than the October forecast. Higher-than-expected domestic demand dynamics also contributed to a worsening external imbalance. The growth rate for the wider monetary aggregates increased to 6%-7%, and credit growth continued to recover.

The Board agreed that, in comparison to the October forecast, the newly available data increased the risks on both sides of the forecast and, in turn, the overall uncertainty related to future economic development. There was consensus among board members that global developments would shift the balance of risks in an anti-inflationary direction, because the foreign economic growth forecasts were adjusted downward. Foreign prices and foreign demand would help slow domestic inflation. One view expressed that even the adjusted global development forecasts anticipated a slight recovery as early as next year. It was also mentioned that a reduction in the monetary rates of neighbouring central banks was a reaction to information the CNB had already reflected in its interest rate decision-making.

The Board also discussed what the main sources of domestic economic growth had been in an environment of weakened foreign demand. It was repeatedly stated that the newly available GDP figures, including newly revised data for 2002 Q2, pointed to household consumption as being the main source of growth this year. The demand fiscal impulse was less significant than originally expected. In this respect, however, it was added that household consumption was supported to a certain degree by fiscal transfers and that it was not easy to clearly differentiate between these two sources of growth. Furthermore, it was expressed that estimates of the overall fiscal impulse were very difficult to form using the available data and that there was considerable uncertainty relating to the extent of fiscal expansion. Another view expressed that the fiscal impulse, whose impact had been expected this year, could be carried over to 2003. It was stated that slowed economic growth had not been caused by weakened foreign demand alone, but also by the supply side of the economy. It was further expressed that consumption of the population was supported more by temporary factors, and therefore, this growth must slow down over time.

The fact that low GDP growth was observed accompanied by strong domestic demand and more rigid supply was repeatedly indicated as an argument against lowering rates. A deteriorating current account deficit was commonly associated with strong domestic demand. An interest rate cut could cause the external imbalance to deteriorate even further. However, the domestic economy had been faced with external constraints and even raising the current account deficit had its limits. In addition, cutting rates was not an appropriate economic instrument for stimulating more rigid supply. It was repeatedly stated that the structure of domestic growth factors had inflationary tendencies.

The Board discussed whether or not the anti-inflationary risks could outweigh the pro-inflationary risks and whether a reduction in rates would be an appropriate monetary policy response. It was repeatedly expressed that the effects of easing monetary conditions caused this year by interest rate cuts and exchange rate developments would fully materialise during 2003.

At the close of the meeting, the Board decided unanimously to leave the CNB two-week repo rate unchanged at 2.75%.

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

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