Minutes of the Bank Board Meeting on 30 October 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 large October situational report, containing the new forecast for inflation and other macroeconomic variables.

Year-on-year inflation in September no longer displayed negative values. However, this upwards shift was not as significant as expected, due in particular to the year-on-year decline in food prices and lower adjusted inflation growth. External cost factors in combination with exchange rate developments prompted a slight year-on-year rise in import prices for Q3. Industrial producer prices ceased to decline year-on-year, and agricultural producer prices experienced growth. Compared with the July forecast, however, cost factors were slower to affect inflation in the absence of demand pressures (expressed by the negative output gap).

The forecast anticipated gradual acceleration of year-on-year inflation to the lower half of the inflation target during the period of the most effective transmission. The reasons behind this development were the dwindling disinflationary effect of cost factors and the expected corrections in indirect taxes. In contrast to the July forecast, the inflation path was decreased, especially in the short term.

Two important factors for the forecast correction in comparison with the July forecast were the weakened intensity of cost effects when transmitted to inflation and a partial reduction in the estimate of the secondary inflation effects associated with the anticipated increase in indirect taxes. A third factor in the forecast correction was related to reducing the trajectory of regulated prices during the next four quarters.

The economic growth forecast had not changed significantly. The growth rate for this year was adjusted slightly upwards to 2.8%, and in 2004, it should be around 3%. The forecast continued to anticipate a change in the structure of economic growth. This year, growth was pulled in particular by household consumption. In 2004, a certain decline in the rate of household consumption was expected in reaction to slowed dynamics for real disposable incomes. At this time, however, an investment recovery encouraged in particular by renewed economic growth abroad was expected. Foreign recovery along with a more relaxed exchange rate component for monetary conditions should also help net export contribute favourably to GDP growth. During 2004, government consumption would be affected by the anticipated public finance reform. As a whole then, the forecast during the most effective period of transmission did not expect more substantial demand pressures on inflation.

The alternative scenarios considered the uncertainty associated with the tempo of real equilibrium exchange rate appreciation and the level of real equilibrium exchange rates. In comparison with the forecast's baseline scenario, the alternative scenarios implied a somewhat higher interest rate path.

Interest rates just below 2% and a slight rise in these rates starting in the second half of 2004 were consistent with the October forecast.

Following the presentation of the situational report, the Board turned to a discussion of the new forecast and the risks associated therein. There was overall consensus among board members that the economy was operating in a low-inflation environment characterised by the absence of more significant inflation pressures. Board members considered the forecast risks to be relatively balanced.

In support of leaving rates unchanged, it was expressed repeatedly that the period of disinflationary cost effects was coming to an end and that a wide range of indicators supported this theory (neutral to slightly pro-inflationary import prices, a halt in industrial producer price deflation, food price growth, looser exchange rate conditions, etc.). Thus, the gradual turning point in year-on-year inflation development was approaching. At the same time however, it was argued that a low-inflation environment still prevailed in the economy.

The Board also focused their discussion on changes of a structural nature that could significantly affect inflation. One view expressed that monetary policy could not immediately offset these structural effects.

Uncertainties were still a factor involved in developments abroad. Although expectations related to economic growth and inflation abroad had not changed to any great extent in comparison with the July figures, some board members believed that there was a higher likelihood now that these assumptions would actually materialise. In contrast to this view, it was mentioned that foreign recovery was still tenuous and that it may still be a while before this process would be set in motion. The effects of regrouping catering and food services into the base VAT rate were considered to be a pro-inflationary risk. It was expressed that after the inflationary effect of certain tax rates subsided, inflation could then fall again below the inflation target.

At the close of the meeting, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged at 2%. Six members voted in favour of this decision, and one member voted for cutting rates by 0.25 of a percentage point.

Author of the Minutes: Vladimír Bezděk, CNB, Adviser to the Board

Comments are welcome on the following email address:Vladimir.Bezdek@cnb.cz