Minutes of the Bank Board Meeting on 27 March 2003

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), Bohuslav Sobotka (Czech Minister of Finance)

The Board opened the meeting with a presentation of the March small situational report, assessing whether the newly available information was consistent with the assumptions of the January forecast.

Year-on-year consumer price growth in February 2003 was slightly below the level of the January forecast. The decline in food prices and regulated prices contributed to this development, while "adjusted" inflation slightly exceeded expectations. Agricultural producer prices ended significantly below the forecast and affected prices in the food industry as well. So far, this factor more than compensated for the rapid rise in oil product prices and caused industrial producer prices to fall below the forecast. The changes in indirect taxes, though not yet approved, were the largest risk for inflation development in the range of monetary transmission.

The price of oil was a significant risk factor in view of external economic developments. The associated uncertainty had increased greatly in connection with recent geopolitical developments. Pessimism concerning world economic recovery was still on the rise.

The exchange rate vis-à-vis the euro showed moderate weakening against the assumptions of the January prediction. The money aggregates showed relatively slow growth. However, harmonised data according to ECB methodology, which assumed a closer link to demand developments, registered higher dynamics. Lending rose year-on-year by about 5%.

The published GDP data for Q4 2002 corresponded to the CNB's forecast. Growth was supported by domestic demand. Household consumption dynamics were comparable to 2001. Government consumption rose at a very rapid pace. However, the change in statistical methods - not easily distinguished from material changes - could have an effect on the published figures. Fixed capital investment was more or less flat, and net export deteriorated significantly.

This was also consistent with the data on the balance of payments. The trade balance showed improvements in 2002, which nevertheless, were concentrated more in the first half of the year. During the second half of the year, the trade deficit was flat on the whole. Moreover, prices, in particular, contributed to this development, while the trade deficit in real terms had already risen. In 2002, the balance of services was the most negatively affected item on the current account. This primarily involved a reduction in the tourist industry's surplus and, to some degree, deterioration in the category of other services as well. The balance of incomes also worsened, the reinvestment of profits playing the largest role. The financial account remained in surplus, however in the last quarter of 2002 itself, it was no longer sufficient for covering the current account deficit.

Following the presentation of the situational report, the Board turned to a discussion of the risks related to the current inflation forecast and how they would affect interest rate decisions. There was consensus among board members that the actual risks had not changed significantly against the previous months. The level of uncertainty, nevertheless, had risen in relation to foreign developments as well as to certain domestic factors.

It was stressed that the expected changes in indirect taxes were the largest risk from the quantitative point of view. The likelihood of implementing these changes was high, because they primarily involved tax harmonisation. As a result, inflation could end up temporarily above the upper boundary of the targeted band. Some board members, on the other hand, pointed out that the impact of indirect tax changes fell under an escape clause as far as reaching the inflation target was concerned. In this respect, it was reminded that the existing forecast, showing inflation gradually moving back towards the target, was based on cost factors that may not necessarily occur or that could be outweighed by the anti-inflationary effect of the negative output gap. Contrary to this, however, it was said that the expected rise in inflation was simply the result of strong disinflationary impulses dying out. Actual negative year-on-year inflation was not associated with the standard features of a deflationary economy and was only short term in nature.

A considerable amount of time was devoted to interpreting the GDP figures. One view expressed that, from the standpoint of monetary policy decision-making, the figures did not introduce any new information potentially leading to further rate cuts. The data, in fact, corresponded to the forecast. However, some board members pointed to the risks of GDP growth. With the exception of government consumption, the sources of demand showed weakening tendencies, and it was difficult to find arguments in favour of growth acceleration this year. The forecast for private consumption could be reassessed downward, and the negative income effect of expected tax changes could add to this development. Global economic recovery was still put on hold. The demand factors of inflation were, therefore, difficult to identify. In comparison with the past, the risk related to excessive wage growth also appeared to be lower. Inflation expectations, after a long time, now seemed to have settled at a lower level, even on the labour market. Behaviour in the area of wages was, therefore, changing.

One issue still remained somewhat open: the Czech economy had achieved rather low levels of growth compared to neighbouring transitional economies, despite relatively loose monetary policy. One explanation could be that the economy was very sensitive to the strong exchange rate last year. Another explanation could be associated with the existence of rigidities on the supply side, especially the low level of flexibility on the labour market.

At the close of the meeting, the Board decided unanimously to leave the CNB two-week repo rate unchanged at 2.50%.

Author of the Minutes: Tomáš Holub

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