Minutes of the Board Meeting on 22 December 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 December situation report, which analysed the new information and assessed the risks associated with the fulfilment of the October forecast.

Annual inflation had fallen from 2.6% in October to 2.4% in November. The forecast had been for a rise to 2.9%. Except for administered prices, which had recorded somewhat higher-than-forecasted growth, all the components of inflation had contributed to the decrease in inflation relative to the forecast. The summer increase in excise duties on cigarettes had not yet passed through to prices. Industrial producer prices and import prices had remained subdued, fluctuating below the forecasted figures. Agricultural producer prices had been in line with the forecast in November.

Third-quarter GDP growth had borne out the predictions of the October forecast in terms of both intensity and, for the most part, structure. Private consumption was recovering modestly in line with the forecast. Government consumption was rising faster than forecasted. This deviation can be put down to the one-off inclusion of military hardware imports under government consumption. The forecast of a modest pick-up in investment demand had materialised. Real exports and imports of goods and services had seen higher-than-predicted third-quarter growth. Exports had continued to outpace imports, although the positive contribution of foreign trade to GDP growth had been rather smaller than forecasted. The evolution of industrial and construction output in October and the bullish expectations of businesses and consumers suggested continuing economic growth in the coming quarters. The new data from the labour market were also consistent with the October forecast.

After the presentation of the situation report, the Board discussed the risks to the fulfilment of the October forecast. The Board agreed that there were no demand pressures on inflation apparent in the economy. The risks of the October forecast were assessed as being on the downside.

The exchange rate was identified as the biggest downside risk, having been stronger than assumed in the forecast. It was said that the extent of the appreciation could not be explained either by changes in the interest rate differential or by new fundamental factors. The current exchange rate trend may also be linked with weaker liquidity in the market due to lower trading at the year-end. Concerns were raised that the stronger exchange rate might pose a risk to the competitiveness of the Czech economy, as the nominal unit wage costs of industrial enterprises expressed in euro, unlike those expressed in koruna, are not falling.

The Board agreed that so far there was no visible pass-through of cost pressures to inflation. It was said that the economy was displaying a considerable ability to cope with the high prices of oil. During the discussion of oil prices, it was mentioned that their current koruna level and the outlook for the next few quarters are essentially in line with the assumptions of the October forecast. It was said that the faster-than-forecasted fall in fuel prices might be associated with strong competition on that market. The negative annual adjusted inflation excluding fuels and the low import price inflation and industrial producer price inflation were also mentioned in the discussion of the downside risks. The opinion was also expressed that core inflation would remain very low despite higher headline inflation.

The upside risks relative to the October forecast were generally viewed as less significant. Most attention in this respect was devoted to the higher interest rate level in the euro area, which, following the logic of uncovered interest parity, necessitates an increase in domestic interest rates. However, it was said that this upside risk to inflation was moderating the downside risks stemming from the currently stronger nominal exchange rate. Doubts were also expressed about Euribor rates staying at their present levels for much longer.

The Board discussed at length the increase in social expenditure being planned for 2007 onwards, which has been subject to approval in Parliament in recent weeks. According to preliminary analyses, these measures will have an impact on the state budget of tens of billions of koruna a year. There was broad agreement that these proposals will not contribute to the stabilisation of public finances. It was said that boosting expenditure at a time of solid economic growth constitutes procyclical fiscal policy. Such a fiscal policy creates risks that will materialise when the current economic boom weakens. A disturbance to the fiscal consolidation process, moreover, might pose a threat to the adoption of the euro within the timescale declared by the government. Concerns were also raised about the combination of easy fiscal policy after 2007 and the increased inflow of funds from the EU budget.

After discussing the situation report, the Board decided unanimously to leave the two-week repo rate unchanged at 2%.

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

Please send any comments to the author: Vladimir.Bezdek@cnb.cz