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 Štěpánek (Chief Executive Director)
The Board opened the meeting with a presentation of the small August situational report, assessing the consistency of the newly available information with the July forecast assumptions.
Inflation in July 2003 corresponded in principle with the forecast, which anticipated year-on-year price stability. In particular, the absence of the usual rise in regulated rent contributed to another reduction in year-on-year inflation. Contrary to expectations, there was a more substantial seasonal decline in food prices in July. On the other hand, recreation prices registered higher-than-expected growth.
Year-on-year M2 dynamics in July 2003 accelerated at a relatively rapid pace. However, the main reason behind this development was the low initial base last year. Credit growth continued to accelerate, especially in the household sector. Following the last cut in monetary policy rates, interest rates for the money market had slightly declined. The actual shape of the yield curve indicated expectations of stable rates on the market. Annual real interest rates, calculated using measured inflation expectations, were flat on the whole.
External cost factors deviated in an upward direction from the forecast. Global prices of oil and certain other raw materials were higher. In comparison with the forecast assumptions, the exchange rate of the Czech koruna was also weaker vis-à-vis the euro and the dollar. Import prices, therefore, declined only slightly in June 2003 and were now above the level of the forecast. However, this had not yet affected industrial producer prices, whose year-on-year decline corresponded for the most part with the forecast. Agricultural producer prices experienced a faster-than-expected turn towards year-on-year growth.
The data from the real economy indicated that a relatively satisfactory level of economic growth had been reached even in an environment of weak foreign demand. Retail sales rose significantly, which implied possibly higher growth for household consumption and GDP in Q2 2003 than the forecast predicted. Favourable development continued in June 2003 for industry as well. The foreign trade figures for July pointed to accelerating import and export dynamics. The substantial reduction in the balance of services surplus in Q2 would, on the other hand, have an adverse effect on GDP growth. In line with the assumptions, the seasonally adjusted unemployment rate was more or less flat. The forecast also corresponded to wage developments.
Following the presentation of the situational report, the Board turned to a discussion of the risks related to the current forecast. As in the last meeting, some board members once again expressed concerns that the existing forecast could overestimate the effect of certain anti-inflationary factors. In addition, some short-term cost risks were now starting to show up on the inflationary side. These factors included in particular oil prices, agricultural producer prices and the exchange rate.
There was overall consensus among board members that weakening of the exchange rate was one of the most significant real deviations from the forecast assumptions. This weakening could be linked to a decline in FDI inflow and a rise in repatriated profit, a low interest rate differential, a more realistic financial market outlook for the euro accession date in countries of the region, and uncertainty associated with implementing fiscal reforms. The board members, however, put various degrees of emphasis on these factors. One view expressed that, if the exchange rate were maintained at a weaker level for a longer period of time, this could have a favourable effect on the economy, and in turn, a stronger impact on inflation. On the contrary, however, it was stated that without more discernible recovery in the EU, the exchange rate alone could not play a large role in reviving Czech foreign trade.
According to some board members, a significant source of uncertainty was the timing and the form that the public finance reform would actually take. There was a substantial risk that the reform would be loosened during legislative proceedings and that its structure would also adversely change in favour of measures on the income side of public finances. This risk could already show up during preparations for and approval of the 2004 state budget proposal. Delaying reform measures on the expenditure side would inevitably mean implementing stricter measures in the future, accompanied by unfavourable effects on economic performance and stability. There was also more of a danger that excessive wage growth would continue in the public sector, and this, in turn, could have negative effects on wage development in the corporate sector.
A considerable amount of attention was devoted to household lending growth. A concern was expressed whether the low interest rates might not create a bubble in this area. If the ability of households to pay off their loans worsened, this could then have a negative impact on macroeconomic and financial stability in the future. The Board would consider this matter further.
The Board also discussed economic developments abroad. The Q2 2003 economic growth figures for the EU were disappointing. However, optimism concerning future development of the global economy was on the upswing. For the time being, this mainly concerned the United States and Japan. Nevertheless, it was expressed that any recovery in these countries would sooner or later find its way over to Europe.
There was overall agreement among board members that the forecast risks were directed upwards, though only slightly. The low-inflationary assessment of the current economic situation would not change substantially, and there was no danger of not reaching the inflation target in the medium run. If the existing risks were to materialise, this could merely accelerate the expected turn in year-on-year inflation developments towards the CNB's targeted band.
At the close of the meeting, the Board decided unanimously to leave the CNB two-week repo rate unchanged at 2%.
Author of the Minutes: Tomáš Holub, Adviser to the Governor
Comments are welcome on the following email address: Tomas.Holub@cnb.cz