Minutes of the Board Meeting on 26 May 2005

Present at the meeting:

Z. Tůma (Governor), L. Niedermayer (Vice-Governor), M. Singer (Vice-Governor), M. Erbenová (Chief Executive Director), J. Frait (Chief Executive Director), R. Holman (Chief Executive Director), P. Řežábek (Chief Executive Director)

The meeting opened with a presentation of the May situation report, which assessed the new information and the risks associated with the fulfilment of the April macroeconomic forecast.

In April the consumer price index had recorded a year-on-year rise of 1.6%, which was 0.1 percentage point higher than forecasted. The deviation was a result of higher-than-expected growth in fuel prices. Import prices in April had been only slightly lower than forecasted, whereas agricultural producer prices had fallen more sharply. By contrast, industrial producer price inflation had been rather higher than forecasted.

Worse-than-forecasted figures for both industrial and construction output, suggesting slowing investment growth, as well as the leading growth indicators signalled lower-than-expected GDP growth in the past quarter. Information from the labour market indicated lower-than-forecasted growth in wages and salaries. Unemployment was in line with the forecast, as was the exchange rate.

After the presentation of the situation report, the Board discussed the risks associated with the fulfilment of the April forecast. The board members agreed that the risks of the forecast could be assessed as balanced. It was said that the new data had confirmed the positioning of forecast and that there was no reason to change the assessment of the macroeconomic situation. The current interest rate settings were consistent with the forecast. The Czech economy remained a low-inflation economy, and there were no major demand-pull inflationary pressures visible at the monetary policy horizon.

The Board agreed that developments in the euro area posed the most significant anti-inflationary risk. Specifically, the potential economic growth slowdown in the euro area could cause the ECB to lower interest rates. Some of the board members expressed concerns about domestic economic growth, referring to the probable slowdown in investment growth. It was also noted that economic growth in 2005 Q1 might have been slowed by the appreciation of the koruna at the end of last year and the beginning of this year. It was hypothesized that accession to the EU had constituted a positive exogenous shock that had boosted economic growth, and that this positive effect was now waning.

The Board stated that the greatest internal risk was uncertainty over fiscal developments and that this represented an upside risk to inflation. On one side were the obligations of the Czech Republic and the plan approved by the Ministry of Finance and the government, and on the other side were recent remarks made by members of the government which went in a different direction and admitted the possibility of higher-than-planned deficits. The effect of fiscal policy on the economy was therefore exceedingly difficult to predict.

The Board also turned its attention to the exchange rate. It was said in the discussion that the recent weakening of the exchange rate should not be overplayed. The depreciation was linked more with developments in the region than with developments in the domestic economy. In this regard, the board members agreed that the risk of a unidirectional movement of the exchange rate had passed and that the exchange rate uncertainty was currently distributed symmetrically.

The settings of the monetary conditions in the euro area and their effect on the Czech economy were also discussed. Some of the board members expressed doubts about the sustainability of the negative interest rate differential between domestic and euro area rates. In this regard it was again emphasized that domestic rates were at the right level given the low domestic inflation.

After discussing the situation report, the Board decided unanimously to leave the two-week repo rate unchanged at 1.75 %.

Author of the Minutes: Juraj Antal, Adviser to the Bank Board

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