Minutes of the Board Meeting on 25 March 2004

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 March situational report assessing the new information and risks associated with the inflation forecast from January of this year.

Year-on-year consumer price growth in February was in line with the forecast. The 0.2% increase against January was influenced among other things by a time lag in the effect of excise tax corrections on cigarette and alcohol prices, because these goods had still been largely supplied using old inventories. Industrial producer prices experienced faster growth for the supply of water, electricity and heat. In agriculture, this growth was concentrated in the area of crop production.

The January figures pointed to the stability of favourable industrial production development. The figures confirmed that GDP growth was expected to remain at around 3%. In spite of this, the number of unemployed was on the rise, reflecting the deepening structural problems on the labour market. The expected slowdown in the growth of household consumption expenditures was taking place. Due to a rise in government investment, gross fixed capital creation increased in Q4 by almost 5%.

In the external environment, the estimates of this year's economic growth in Germany were being gradually lowered, and the new inflation forecasts would also shift downwards. The effect of higher global oil and natural gas prices on the price level in the Czech Republic had been offset thus far by a stronger Czech koruna vis-à-vis the dollar.

The situational report indicated the rise in agricultural production prices as a current risk to the short-term inflation forecast. The assessment of the impact of indirect tax changes was marked by uncertainty. According to the draft bill passed by Parliament, the primary impact of these taxes on inflation as of 1 May was for the most part non-existent. However, one risk was the secondary effects conditional on inflation expectations and to what extent the changes in VAT rates would be reflected in prices.

Following the presentation of the situational report, the Board discussed the significance of the new information and figures for monetary decision-making. There was consensus among the members that the new information did not justify a change in the economic and monetary outlook.

A similar conclusion was also valid for the assessment of risks. The Board discussed the inflation risks originating from the growth of agricultural producer prices and the risks associated with high global oil prices. The notions on indirect tax changes had become more and more clear. However, the change in regulated rent was still uncertain. The appreciated koruna exchange rate vis-à-vis the dollar and economic development in the EU continued to have an anti-inflationary effect. As a reminder, however, it was mentioned that economic growth in the USA and China was a substantial incentive for the global economy.

The Board considered inflation expectations to be the most significant uncertainty at present. Expectations were now formed, in particular, by judgements made about the results of the specific steps of public finance reform and EU accession. In this respect, the media's influence on the general public in forming inflation expectations and its possible one-sided effect were discussed. It was expressed that, after the effects of tax changes died out, inflationary pressures would lessen and inflation expectations should decline.

Based on the figures for Q4, GDP growth was perceived to be relatively satisfactory. Some doubts about the sustainability of this growth, however, were expressed in view of slow growth in private business investments, household savings, a slowdown in foreign direct investment inflow and the structural imbalance between supply and demand on the labour market. Uncertainties concerning upcoming economic developments, especially unemployment, wages and prices, were reflected in the current lag in household consumption growth. One view expressed that delayed consumption could also be related to the planned reduction in the base VAT rate, which would make more costly long-term consumption items less expensive.

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: Petr Krejčí, Adviser

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