Minutes of the Board Meeting on 27 October 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 discussed the 10th situation report, containing the new macroeconomic forecast.
The inflation forecast had shifted upwards compared to the July forecast, primarily because of a cost shock in the form of rising energy prices and a revision of the prediction for regulated prices. The growth in fuel prices was much higher than the July forecast had expected. The first-round effects of the rise in energy prices would disappear at the monetary policy horizon, but the cost pressures would generate a rise in inflation expectations. Monetary policy responded within the forecast to the second-round effects of the rising energy prices. As a consequence of these second-round effects, inflation would remain higher than in the July forecast and fluctuate just above the point inflation target at the monetary policy horizon.
The demand climate, however, remained modestly anti-inflationary. The negative output gap was rather narrower than the July forecast had predicted, reflecting the buoyant GDP growth in the first half of this year. This economic growth had been fostered chiefly by an improvement in net exports, although the rate of growth of both exports and imports had slowed markedly. The forecast expected the output gap to widen in the immediate future, owing to the combined effect of energy rice growth, a tighter real exchange rate, more restrictive fiscal policy and persisting low external demand. Closure of the output gap was pushed back beyond 2007. After this year's high GDP growth, the forecast expected a slightly lower rate of growth in 2007.
Consistent with the October forecast was a gradual rise in interest rates.
After the presentation of the situation report, the Board discussed the new forecast and the risks thereto. It started off by addressing the issue of the second-round effects of the rise in energy prices. It was said that the higher energy prices were having a double impact. On the one hand they were fostering a rise in inflation, and on the other hand they were reducing disposable incomes. The uncertainty surrounding the intensity of the second-round effects of the rise in oil prices on other price categories was viewed as considerable. Given the uncertainty regarding the intensity of the price spillovers, which would not emerge until later on, the opinion was expressed that it would be better to increase rates in line with the forecast now and thus avoid the risk of a need for faster growth in rates to a higher level in the future. It was also said that the alternative scenarios assuming less intensive spillover of the price growth also implied a rise in rates. The Board agreed that real interest rates were falling as a result of the rise in inflation. Some of the members regarded this, in the context of buoyant economic growth, as an argument for raising nominal interest rates. The view was also expressed that an increase in rates would only be appropriate if the cost shock generated a longer-term shift in inflation towards the inflation target.
The Board then turned to the issue of forming inflation expectations. The view was expressed that successful stabilisation of cost shocks is determined by the ability of central banks to anchor inflation expectations. It was noted that given the credibility of monetary policy, the rise in inflation expectations would not necessarily be significant. Attention was also drawn to the experience with the historically low impact of cost shocks and tax changes on inflation. The opinion was expressed that the rise in prices would not be disproportionately reflected in wage bargaining. By contrast, some of the members regarded upward pressure on wage growth as possible, given the corporate profitability and high economic growth.
The Board went on to discuss the demand pressures in the Czech economy. It agreed that it currently observed no such pressures in the economy. The opinion was expressed that the forecasted structure of economic growth was not generating demand-pull inflation. Some of the members were not expecting any major upswing in demand in the EU Member States, which would lead to demand pressures from abroad. It was pointed out that the growth in prices of some raw materials had yet to pass through to consumer prices, hence there was potential pressure here for a rise in prices.
In the light of past developments, the Board was not expecting a demand impulse from fiscal policy this year, but there was considerable uncertainty regarding developments next year. Some of the members viewed continuing fiscal restriction as likely. Others voiced concerns about a possible more expansive policy. This argument was supported, among other things, by the fact that fiscal policy in 2005 had not been restrictive intentionally.
The Board continued with a discussion of the global context of domestic inflation. It was said that the higher oil price was a result of growing demand for energy, especially in Asian economies, and was not necessarily transitory in nature. In this regard, it was said that economies today are much better prepared for an oil shock than they were in the 1970s. It was also pointed out that demand for cheap goods from Asian countries, which was depressing prices and contributing significantly to the low-inflation and low-nominal-interest-rate environment worldwide, was a symmetric phenomenon vis-à-vis the current inflation-accelerating excess demand for oil. It was also said that if the long-term inflation trend was higher, and if the low domestic rates were a temporary reaction to the past nominal appreciation of the koruna and the negative output gap, then a rise in rates was the appropriate monetary policy response.
After discussing the situation report, the Board decided by a majority vote to raise the two-week repo rate by 0.25 percentage point to 2% with effect from 31 October 2005. At the same time it decided to increase the discount rate and Lombard rate by the same amount, to 1% and 3% respectively. Four members voted in favour of this decision, and three members voted for leaving rates unchanged .
Author of the minutes: Juraj Antal, Adviser to the Board
Please send any comments to the author at Juraj.Antal@cnb.cz