Minutes of the Board Meeting on 29 May 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)

The Board opened the meeting with a presentation of the 5th situational report on economic and monetary development. On the basis of the latest data, it was stated in the report that the risks associated with reaching the forecast had shifted towards a disinflation path a month after approving the inflation forecast. The main reasons behind this shift were the strengthening Czech koruna vis-à-vis the dollar, current oil prices and subdued price developments abroad. During the second third of May, the dollar substantially weakened. The Consensus Forecasts published in May also indicated that this weak position could continue in the future. In contrast to the original assumptions, the price of Ural oil had declined rapidly in April and the beginning of May. Both factors were reflected in industrial producer prices, which in April were 0.7% lower than a year ago. In addition, agricultural producer prices fluctuated below the forecast assumptions.

Higher gas prices and the regular seasonal increase in the prices of fruit and vegetables contributed most to the 0.2% month-on-month rise in April consumer prices. The moderate decline in other food prices and the fact that fuel prices had started to fall worked in the opposite direction. It was indicated in the situational report that price developments in the Czech Republic significantly differed from the situation in EU countries, where year-on-year growth of consumer prices had been above 2% for several months and year-on-year growth of industrial producer prices was even higher.

It was stated during the presentation of the situational report that the change in indirect taxes in 2004 would affect the year-on-year consumer price index by about 1.5% according to the latest figures, which was less than the estimate in the April forecast. This value involved the direct and expected secondary impact of reduced VAT rates for some services towards the base rate as well as higher excise taxes for alcohol, fuels and tobacco products. Contrary to the forecast assumptions, there would apparently not be a shift to higher VAT rates for the restaurant and hotel industry in the near future.

Year-on-year money supply growth reached an historical low of +2.5% at the end of Q1, which was consistent with the exceptionally low inflation values at this time. The situational report pointed to the different approach to M2 used by the European Central Bank to assess the money supply. If this same approach were applied in the Czech Republic, the current year-on-year money supply growth would be 6%.

In the discussion to follow, the Board confirmed the rise in disinflationary risks since the last situational report. However, various opinions dealt with whether the weight of the newly available information could lead to doubts about the current inflation forecast as the main criterion for monetary policy decision-making. Some board members expressed substantial doubts about whether or not the current forecast was consistent and credible enough and recommended as an exceptional case that a new inflation forecast be submitted early to the Board, i.e. for the discussion of the June situational report. On the other hand, it was argued that the shift in risks for reaching the forecast was a natural process and that this, in itself, was not reason enough to formulate a new forecast. In this respect, it was reminded that the European Central Bank constructed its forecast on a half-year basis. The proposal to reformulate a new inflation forecast in advance was rejected by a majority vote. The forecast would be submitted as scheduled at its regular July meeting.

A number of opinions surfaced during the discussion on whether the present exogenous factors were predominantly short-term in nature or whether they had a medium-term character. Some members pointed out that, besides the exogenous risks, there were also significant endogenous disinflationary factors to deal with, such as the increasing negative output gap, agricultural producer prices and the impact of the planned fiscal reforms on wages and other incomes of residents. Emphasis was put on the need to more carefully analyse the development of household indebtedness in relation to the rapid growth of bank and non-bank consumer loans.

It was expressed that the proposal for public finance reform was going in the right direction. This, however, was only the first step, and the proposal as it stood now was not sufficient enough for sustaining public finance development. The new information and changes in the area of indirect taxes were discussed in depth. It was reminded that the recent medialisation of the rise in VAT rates for some services disproportionately amplified its impact on inflation and, in turn, increased the likelihood of higher unfavourable secondary effects from this change.

At the close of the meeting, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged at 2.5%. Five board members voted in favour of the decision, and two members voted for reducing the rate by 0.25 percentage points.

Author of the Minutes:

Petr Krejčí, Adviser

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