Minutes of the Board Meeting on 29 September 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 Board was presented with the September situation report assessing the new information and risks associated with the fulfilment of the July 2005 macroeconomic forecast.

As in the previous month, annual consumer price inflation had been 1.7% in August. Just like in July, annual inflation had been 0.3 percentage point lower than the latest forecast, as the higher-than-expected growth in fuel prices had not offset the downward deviations. Adjusted inflation excluding fuels had been lower than predicted, as had growth in administered prices, owing to the delayed impact of higher excise duties on tobacco products. Agricultural and industrial producer price inflation had been in line with the forecast, while import prices had been higher than forecasted thanks chiefly to oil prices.

GDP growth in the second quarter of 2005 had been higher by comparison with the current forecast, thanks mainly to better-than-expected net exports. Year-on-year household consumption growth had also been faster. Conversely, gross fixed capital formation had been lower than forecasted. A revision of the previous GDP growth data had been published at the same time as the new figure. This revision had partly changed the view regarding the growth in last few quarters. Prior to the revision, the data from early part of 2004 had indicated a gradual slowdown in quarter-on-quarter growth, whereas according to the new figures the economy had been showing an accelerating growth trend since 2002. Unemployment was broadly in line with the forecast, but wage growth in the enterprise sector was slower.

After the presentation of the situation report, the Board discussed the risks to the fulfilment of the July forecast. The Board agreed that there were risks in both directions and that they were more pronounced than in the past. The monetary conditions were in line with the forecast, the rather tighter exchange rate component thereof being balanced by slightly easier interest rate conditions.

Prices of energy - most notably oil and natural gas - were viewed as the main upside risks to inflation. While the July forecast predicted some fall in oil prices over the coming quarters, the Board felt that there was a major risk of the high prices of energy-producing materials persisting in the longer run. The degree of pass-through of the cost shock into inflation expectations and wages is a monetary policy risk. Some of the board members also pointed out the rise in inflation in the main European and world economies and mentioned the risk of transmission of the related inflation pressures into the domestic economy.

The exchange rate is fostering lower-than-forecasted inflation, having been rather stronger than assumed in the forecast over the past quarter. Another downside risk is the recent evolution of inflation, even in the context of the faster-than-expected growth of the economy. The low industrial producer price inflation was also emphasised in the discussion of the downside risks. However, it was also said that this might be a case of compensation of the past high growth of these prices. It was repeatedly mentioned that the low money supply growth suggested very weak inflation pressures. Against this, though, it was said that lending growth was fairly robust in all segments, and it was also mentioned that in the short run monetary aggregates are an unreliable indicator of future inflation.

The Board also dealt in detail with the significance of the newly published GDP growth figures. The board members agreed that the deviation of the new figures from the prediction required in-depth analysis. A detailed examination of the GDP data, including the linkage between inflation and the output gap, would form part of the new October macroeconomic forecast. It was pointed out that one of the factors underlying the high annual GDP growth was a large deterioration in the terms of trade. The internal consistency of the current data was discussed, and the opinion was expressed that a downward revision of these figures was more possible than in the past. The uncertainties were concentrated mainly around the measurement of net exports and their deflators. In addition, the Board discussed the possible structural discrepancies between data on GDP resources and expenditure, and attention was likewise drawn to the weak link with events on the labour market, where part of the statistical improvement may have been associated with administrative changes rather than economic factors. Attention was also drawn to the low corporate investment in the global economy, which was persisting despite the low level of real interest rates. This poses a major risk to domestic investment demand as well.

The Board also discussed the relatively fast growth in loans. The opinion was expressed that the combination of relatively fast economic growth, the expansion in lending to households, the rise in corporate loans and the low real interest rates was raising concerns going forward. This notwithstanding, it was said repeatedly that the time structure of lending was balanced, as the volume of long-term corporate loans was also rising and the financial sector should be capable of adequately assessing the risks. The view was expressed that while mortgage lending was being stimulated by the current monetary policy settings, the link with monetary policy rates was weaker in the case of consumer credit, owing to the high level of rates in this segment.

The Board said that the state budget was developing very favourably, thanks mainly to high tax revenues. It was said repeatedly that budget policy was nonetheless too easy given the current economic developments. There was broad agreement that the future fiscal path is a major source of uncertainty for the CNB's decision-making.

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

Author of the minutes: Martin Cincibuch, Adviser to the Board

Please send any comments to the author at martin.cincibuch@cnb.cz