Minutes of the Board Meeting on 27 May 2004

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

The Board opened the meeting with a presentation of the May situational report assessing the new information and risks associated with the April macroeconomic forecast.

April consumer inflation was slightly lower than was originally predicted in April due to accumulation of certain deviations within individual inflation segments. On the contrary, production - industrial and agricultural producer prices - rose at a slightly faster pace than predicted. Agricultural producer prices showed accentuated dynamics in the last few months, which, however, did not reflect in the food prices. Import prices were slightly higher in March than forecasted. External environment predictions were not significantly amended during the last month, with the exception of increased oil price estimates, as these reflected the unfavourable situation on the world markets.

The real economy figures, especially industrial and construction production indicated increased economic growth, which should according to the forecast be due to the revival of investment activity and increased export dynamics. The slowing down pace of retail sales in the first quarter was consistent with already forecasted expectations of the deceleration of consumer demand dynamics. The situation on the labour market was from the standpoint of the unemployment rate as well as the employment indicators in principle consistent with the forecast. M2 growth kept accelerating in March, however, dynamics of lending growth did not increase. The trade deficit for the first four months was sluggish in year-on-year nominal terms, although the balance in March and April was worse than predicted.

Following the presentation of the situational report, board members turned to a discussion on the risks of the April forecast fulfilment. The Board agreed that the new data gave no reason to change the overall view of the economic situation. In consistency with the April board meeting, the risks of the forecast were in relation to the inflation as well as from the economic growth standpoint shifted downwards.

When discussing economic growth there was an overall consensus that it was accelerating. It was repeatedly said that the risk of the forecast could be the different recovery structure in the sense of lower net export and private consumption contribution, which could be compensated by faster investment dynamics. An assumption was made that this development could be related to the lower demand inflation pressures. It was, however, also said that there was not enough empirical evidence to support this theory. The risk in relation to net exports was repeatedly found in an uncertain foreign demand perspective, especially in Europe. A different growth structure could also reflect the CZK exchange rate development vis-à-vis the euro, which was moving in stronger values against the forecast assumptions. In connection with domestic economic recovery it was also said that its risk could be the low flexibility of the supply side of the economy.

From the viewpoint of pro-inflationary pressures the attention was focused especially on cost factors. The Board agreed that the assessment of the risks resulting from oil price growth in relation to inflation and economic growth could be very difficult. For the short-term outlook the high oil prices signified a pro-inflationary risk. The possible persistent oil-price shock could however in the longer term weaken the world's prosperity, which should in the end lower the domestic inflation growth pressures. On the other hand there was an opinion, that due to the improved structure of economies the global resistance against the oil shock was higher than in past decades.

Apart from oil, agriculture producers prices were also discussed. It was said that its dynamic growth compensated on most levels the sifting of the price level in the past years and that the effect on food prices was limited. It was, however, mentioned that agriculture producers price growth could be influenced by new circumstances associated with the opening of the European agricultural market after the Czech Republic's EU accession.

Fiscal policy was also discussed. It was said that not only monetary but also fiscal policies were both responsible for sustaining a stable economic environment in the closing output gap situation. A concern was expressed that higher tax income caused by the acceleration of economic growth could be used for additional pro-cyclical spending, which would weaken the structural scope of fiscal consolidation. Cautious fiscal policy was also important because as of this year the fiscal system should be facing uncertainties connected with the budgetary effects of the financial flows between the Czech Republic and the EU.

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

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

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