Minutes of the Bank Board Meeting on 27 November 2003

Present at the meeting: Z. Tůma (Governor), O. Dědek (Vice-Governor), L. Niedermayer (Vice-Governor), M. Erbenová (Chef-Executive Director), J. Frait  (Chef-Executive Director), P. Racocha  (Chef-Executive Director), P. Štěpánek  (Chef-Executive Director)

The Board opened the meeting with a discussion on the November situational report, assessing the new information and risks associated with the October macroeconomic forecast. During the presentation of the Monetary and Statistics Department, it was stated that CPI inflation in October was higher than the CNB's prediction. This was primarily due to higher regulated price growth, and to a lesser extent, to higher food price dynamics than the forecast predicted. The high dynamics of retail sales in Q3 signalled in all probability faster private consumption growth and apparently even GDP in comparison with the assumptions. From the standpoint of economic growth this year, the continuation of stable industrial output growth in September and the high year-on-year dynamics of construction output were also positively assessed. Signals from the labour market continued to be in line with the assumption of a gradual slowdown in the domestic demand growth rate for next year. The newly available figures confirmed further acceleration of economic growth in the United States. In the European Union, the signs of economic recovery were at this point weaker than in the United States. Inflation in the EU still remained just below 2%. Since the second half of October, the prices of raw materials on the world market indicated a slight recovery in demand. Following the September decline, oil prices in October returned to a higher level, i.e. between USD 28 and 30 per barrel. The rise in the price of oil in koruna terms, however, had been significantly restrained as a result of the sharp weakening of the US dollar vis-à-vis the euro in November and the current stability of the Czech koruna vis-à-vis the euro.

In the discussion to follow, the board members agreed that even if CPI inflation in October rose at a faster pace than the CNB expected, it was so far only the first case of such an occurrence this year, and the weight of this development would not show up until the next economic data were released. In this respect, it was expressed that a more rapid rise in food prices should not be interpreted as a temporary shock, but in view of the sharp decline in agricultural producer prices in the past, rather as a return to the normal price growth path for this segment of the consumer basket.

Attention was also devoted to expected foreign demand developments. The Board said that, in contrast to previous developments, signals of stronger economic growth were beginning to emerge, not only in the United States but in the EU as well. In view of the fact that the economic performance of the Czech economy was influenced to a large degree by economic growth in Europe, especially in Germany, this news was assessed in a positive way.

Next, the Board discussed in detail the importance of the recently published short-term indicators, which signalled strong domestic demand. However, the current forecast assumed a certain slowdown in household consumption for 2004. Favourable information from the economy, though, increased the likelihood that the output gap would close up at a faster rate and that inflation would at the same time return more quickly to the inflation target band. Nevertheless, the board members evaluated the sustainability of consumer demand and the outlook for investment demand next year from a variety of angles. One view expressed that, considering the effect of temporary factors (e.g. the Government's harmonisation efforts in the area of indirect taxes), the anticipated rise in the unemployment rate (indicated by several companies) and the likely decline in the dynamics of real wages next year, continuation of the current dynamics of consumer demand could not be expected, and this would not be offset by increases in investment. In contrast, however, it was stated that the positive future outlook for foreign demand and the existing low level of domestic interest rates created a good base for sustainable domestic demand growth. Therefore, the anticipated decline could be less or would not need to occur at all.

The Board focused on assessing the risks associated with the inflation forecast. Some of the board members' interpretations of the new information implied a possible turning point in inflation development. There was consensus among members that the inflation risks, in the light of the new figures, were slightly pro-inflationary in relation to the forecast. The main short-term inflationary risks for future development were considered to be the indirect effect of tax changes and regulated price increases on inflation next year in an environment of a more rapidly closing output gap and rises in agricultural producer prices and food prices. Another view during the discussion also stated that the increases in electricity and gas prices expected at the beginning of next year had not yet been reflected in the current forecast. The persistence of structural rigidities in the economy, especially on the labour market whose future would be directly affected by the Government's measures in this area, was indicated as a longer-term inflationary risk. The consequences of the somewhat inflexible supply side presented a substantial risk for inflation development at the moment economic growth started to pick up.

At the close of the meeting and following the discussion on the 11th situational report, the Board decided unanimously to leave the CNB two-week repo rate unchanged at 2%.

Author of the Minutes: Tibor Hlédik, Adviser

Comments are welcome on the following email address: Tibor.Hledik@cnb.cz