Minutes of the Board Meeting on 24 June 2004

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

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

May CPI growth was a little lower than was originally predicted in April. A slight downward deviation was seen not only in net inflation but also in the segments of regulated prices. Food prices continued to show lower growth than the forecast. On the other hand, adjusted inflation rose at a somewhat faster pace in May due to fuel prices. Production price development was faster in May than the assumptions in the April forecast. As far as industrial prices go, these mainly reflect the effect of world metal price growth. This factor influenced import prices, which were slightly higher in April contrary to the forecast. Newly available information about the external economic environment led to a slight pro-inflationary adjustment, especially in the area of producer and consumer prices in Germany this year.

The economic growth attained in the first quarter was in line with the April forecast. With regards to its structure, the slowdown in the household consumption prediction was fulfilled. Poorer-than-forecasted net exports and government consumption development was compensated with accelerated investment dynamics. Industrial production development in April shows continued economic growth. April construction output was significantly influenced by the May VAT increase. In the next several months, a temporary year-on-year decline in construction production could be expected. The situation on the labour market in May was, in principle, consistent with the forecast. Wage development in the first quarter was faster than predicted in April, especially in the non-business sector, where the time-scale seasonality change would take place in connection with implementing a 16-scale tariff and with respect to resolving the issue of 13th and 14th salaries. M2 growth kept accelerating in April, as did lending growth.

Following the presentation of the situational report, board members discussed the new economic data and risks associated with the April forecast.

The majority of the Board agreed that, in principle, the newly available data confirmed the positioning of the April forecast, which expected economic growth pulled by investment activity and higher exports. Gradual interest rate growth was also consistent with the forecast for April, even in the case of CZK exchange rate development vis-à-vis the euro according to the alternative appreciated scenario. Some board members pointed out the somewhat, rather different structure of economic growth, in particular, slower export growth. It was also said that the revision of the national accounts, which is currently under way could increase the uncertainty regarding the past and present development of GDP and the output gap.

The Board also focused its attention on the interpretation of the one-off effect of the Czech Republic's EU entry on short-term economic indicators, especially gross fixed capital formation development in the first quarter and also the outcome of construction production in April and the most likely development of this indicator in the next few months. It should be expected that some short-term indicators could show some major fluctuations over the next several months, which would complicate the assessment of economic development.

Further discussed were the causes of existing inflation deviations from the April forecast. The Board agreed that, for the time being, no straightforward explanation existed for why inflation had reached slightly lower values than predicted, despite the stronger pro-inflationary cost pressures. This could be due to a combination of factors such as a more open initial negative output gap, easing of the links between cost factors and consumer prices, or the increase of already high competition on the domestic market. The more gradual time distribution of the primary effects of the indirect tax increase could also play a role.

On the other hand, it was repeatedly said that despite these uncertainties, total as well as net year-on-year inflation were increasing. It was said that faster wage growth and even household lending dynamics could experience a lower consumption rate decline than predicted. Attention was also drawn to the fact that long-term negative real interest rates are not adequate in a scenario of growing inflation and continuing economic growth.

At the close of the meeting the Board decided by a majority vote to increase the CNB two-week repo rate by 0.25 percentage points to 2.25%, effective 25 June 2004. The Board also increased the discount rate and Lombard rate by the same amount to 1.25% and 3.25%, respectively. Three members voted in favour of this decision, and two members voted for leaving rates unchanged.

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

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