Minutes of the Board Meeting on 30 September 2004

Present at the meeting: Zdeněk Tůma (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 discussed the 9th situational report for September 2004 analysing the newly available statistical data and assessing the risks associated with the July macroeconomic forecast.

Year-on-year CPI inflation reached 3.4% in August this year, whilst the CNB expected 3.2%. This small forecast deviation was caused by slightly faster net inflation growth of 2.6% compared to the predicted 2.4%, with slightly slower-than-expected regulated price inflation. Adjusted inflation development (net inflation excluding fuel), an important price indicator from the monetary policy point of view, was in line with the forecast. Faster fuel price growth against the CNB's assumptions was the result of higher world oil prices than was considered in the July macroeconomic forecast reference scenario. Year-on-year August food prices increased faster, and their month-on-month decline compared to July was lower in comparison with the CNB's assumptions. Food prices developments were the result of their high seasonal fluctuations in summer months, and there was no reason for these deviations to be over-emphasised. Industrial producer prices showed faster growth than the CNB expected, especially under the influence of rising prices for energy raw materials, metals and metal intermediates. Agricultural producer prices were to a great extent in line with the July macroeconomic forecast.

The year-on-year GDP growth for Q2 reached 4.1%, and thereby slightly exceeded the CNB forecast assumptions. Also in the economic growth structure, there were deviations from the forecast, especially in favour of higher-than-expected dynamics of fixed investment and real exports, and at the same time, with a stronger-than-expected slowdown in real consumption growth. The year-on-year value-added indicator for industry increased 8.1% in Q2, and a value-added increase was also noted in trade, transportation and construction. In the same period, there was significant improvement in labour productivity as well as in corporate sector financial indicators. The overall year-on-year employment decreased 0.8%. The registered unemployment rate reached 10.2% by the end of August (according to the original methodology of the Ministry of Labour and Social Affairs). In August, the number of unemployed increased by less than four thousand month-on-month, mainly due to the inflow of school-leavers and graduates who registered as unemployed. The development of unemployment was consistent with the CNB's assumptions. Average nominal wage growth in the corporate sector reached 5.9% year-on-year in Q2, and in the public sector, average nominal wage decreased 0.6%. Wage developments were slightly more moderate against the CNB's assumptions.

Following the presentation of the 9th situation report, the Board discussed the risks associated with the July forecast. The board members agreed that the monetary conditions did not significantly deviate from the forecast. New economic development data confirmed in principle the assumptions of the July macroeconomic forecast, and the current interest rate level was consistent with the forecast. From the short-term point of view, the balance of risks was slightly pro-inflationary, whereas in the long-term, which was more relevant to monetary policy, the uncertainty of development of pro-inflationary as well as anti-inflationary factors would rise.

In a discussion about the pro-inflationary risks, there was the issue of stronger economic growth not only on the macro level, but also in relation to the exceptionally high growth of exports and industrial production. In connection with this, it was said that, on the one hand, the acceleration of domestic economic growth meant a pro-inflationary risk. On the other hand, only additional figures would confirm whether the economy was able to keep up with these developments without accelerating inflation, especially due to a favourable economic growth structure along with the predominance of investment, improved supply-side performance of the economy as well as competition growth. Affirmation of this scenario could lead to reassessment of the economy's potential.

The Board also included world oil price growth among the short-term pro-inflationary risks and discussed whether oil prices would show up over the long run mainly in price growth or in a global weakening of the world economic performance. A considerable amount of attention would still be devoted to oil price development as well as the trend by which it should influence the world as well as the Czech economy.

At the moment, the risks of future inflation acceleration could arise from faster domestic growth, external cost factors (oil, metals), and foreign demand. Domestic demand had more of a moderating effect on inflation dynamics. In this respect, the board members discussed the issue of to what extent such development was sustainable with regards to existing cost pressures (growth of industrial producer prices), and to what extent the transfer of cost pressures to consumer prices and demand inflation would be realistic.

Wage development was also amongst pro-inflationary risks, particularly in relation to the already known data on planned wage growth in some parts of the public sector, and a possible influence of these wage pressures on the overall wage level next year. In this respect, the Board would monitor future development, especially the position of trade unions during the start of wage negotiations for the following year. The continuing employment decline could be considered a short-term anti-inflationary factor. The structural problems of the labour market, however, had created long-term pro-inflationary pressure according to the board members, because of limiting the potential GDP growth. Removal of labour market rigidities should thus enable higher potential GDP growth. This would make space for faster non-inflationary growth of the economy, and as a result, also sustaining more relaxed monetary policy.

During the discussion on anti-inflationary factors, slower growth of domestic consumption, retail sales and flat growth of construction production were mentioned in particular, together with signs of improvement in the potential of the economy as well as a favourable economic growth structure. However, some board members emphasised that growth of the potential was limited by the already mentioned structural problems of the labour market, as well as the uneven structure of industrial production growth. In construction production, a continuing slowdown should not be ruled out due to the influence of pre-billing during the first four months of the year.

Following the discussion of the 9th situational report, the Board decided unanimously to leave the CNB two-week repo rate unchanged at 2.50%.

Author of the minutes: Vladislav Flek, Adviser to the Board.

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