Minutes of the Bank Board Meeting on 17 December 2003

Present at the meeting: Zdeněk Tůma (Governor), Oldřich Dědek (Vice-Governor), Luděk Niedermayer (Vice-Governor), Jan Frait (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director)

The Board opened the meeting with a discussion of the December situational report, assessing the new information and risks associated with the October forecast. CPI inflation was somewhat higher in November than the October forecast indicated. Adjusted inflation kept in line with the forecast, but there were more substantial fluctuations in the segment of regulated prices and food prices. This, as a result, had an effect on overall inflation. In Q3, GDP growth was slightly higher than the October forecast. The actual components of GDP deviated considerably more from the expected development. The most substantial deviations from the forecast were seen in household consumption, which increased at a relatively rapid pace, and in inventory changes, which were lower in comparison with expectations. Household consumption dynamics started to overtake disposable income. Unemployment corresponded to the forecast. M2 growth further slowed, and the trend of accelerating credit growth continued. The koruna exchange rate vis-à-vis the euro remained stable despite volatile development on world markets. The continuing trend of private consumption recovery and the effects of administrative tax and price corrections could be included in the inflationary risks associated with the October forecast. The impact of possible changes in key world currencies was a particular downside risk.

Following the presentation, the Board turned to a discussion on the actual distribution of risks associated with the inflation forecast. There was consensus among board members that, in relation to the October forecast, the risks were still predominantly on the inflation side, similar to how it was in November. It was repeatedly stated that the newly available data on inflation and GDP were slightly higher than predicted by the October forecast. In this respect, it was also said that the inflation risks associated with the forecast did not imply that inflation was not in line with the target for the period of the most effective monetary transmission. The existing inflation values were, after all, very low and the October inflation forecast during this period was gradually approaching the lower part of the target only.

The Board discussed whether or not the new inflation figures were a sign that inflation was returning back from its very low values to more standard values. It was mentioned that the factors causing a swing in inflation above the forecasted values were difficult to predict. Adjusted inflation - inflation adjusted for these factors - did not send any signal of demand inflation recovery. It was stated several times that inflation in 2004 would be generated to a certain extent by administrative and tax corrections that did not have a direct link to domestic demand and the output gap. Therefore, even the effect that they had on inflation could not be seen as a convincing signal of renewed inflationary pressures. In this respect, another view expressed that differentiated price development was logical given the conditions in the Czech Republic and that even this type of increase in prices should be accounted for during monetary policy decision-making. This increase in prices would form inflation expectations and directly affect the settings of real monetary policy conditions.

It was said that higher household consumption growth, which was the main reason for GDP deviating from the forecast, could be only temporary in nature. In 2003, real wages increased at a relatively fast pace due to unexpectedly low inflation values. This, in turn, stimulated household consumption growth. Corrections in this development could be expected in 2004, which was also supported by the preliminary information on the outcome of this year's wage negotiations. However, it was also stated that a recovery in consumption growth could be of a more permanent character.

The Board further discussed the development of both components of monetary policy conditions. Members agreed that the stability of the koruna exchange rate vis-à-vis the euro this year was a positive sign, especially in a period of relatively high volatility related to the key world currencies. The Board also discussed the current settings of monetary policy conditions. It was said that, given the level of nominal rates, a rise in inflation would make real interest rates fall below their equilibrium level. However, it would be very difficult in the future to determine the precise turning point for the settings of monetary policy conditions.

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

Author of the Minutes: Kateřina Šmídková, Adviser

Comments are welcome on the following email address:Katerina.Smidkova@cnb.cz