Minutes of the Board Meeting on 23 February 2006
Present at the meeting: Z. Tůma (Governor), L. Niedermayer (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 February situation report, which assessed the new information and the risks to the fulfilment of the forecast contained in the January situation report.
At 2.9%, inflation in January had been in line with the forecast. The dynamics of the individual components of inflation had also been as predicted. Administered prices and adjusted inflation had risen somewhat faster than forecasted, whereas food prices and fuel prices had been slightly lower.
The exchange rate component of the monetary conditions was still considerably stronger than forecasted, while the interest rate component was slightly easier. Information on the evolution of exogenous variables suggested a risk of lower economic growth and higher inflation in Germany in 2007 as a consequence of an increase in the basic VAT rate. However, the impacts of this risk on the Czech economy would be fairly limited. The assumptions regarding the development of euro area interest rates were being fulfilled, as were the assumptions about other exogenous variables and fiscal policy. Newly published supply-side information confirmed the assumptions of continued relatively high GDP growth in 2005 Q4. Annual monetary aggregate growth and credit growth were rising.
After the presentation of the situation report, the Board discussed the risks to the fulfilment of the January forecast. As in the previous month, the Board regarded these risks generally as being on the downside, although they had weakened slightly since the discussion of the January situation report. Unlike in the previous month, there had been a decrease in the uncertainty surrounding the upward path of interest rates in the euro area. The Board felt that the related widening of the negative interest rate differential against the euro might lead to a decrease in the attractiveness of investing in the Czech koruna and thus to a correction of the recent appreciation of its exchange rate, or at least to an easing of the pressures for further appreciation. The opinion was also expressed that, given the current exchange rate expectations, a slight increase in the negative interest rate differential against the euro would not in itself necessarily have any major effect on the appreciation pressures. Some of the members also drew attention to the present negative yield differential for long-term bonds.
The Board agreed that the exchange rate was still the main downside risk, remaining stronger than forecasted. The prevailing view was that this exchange rate development might be a non-systematic deviation. However, opinions were also expressed that the appreciation could be attributed to fundamentals such as foreign direct investment inflow, the buoyant GDP growth or increased export growth, which was being recorded despite the appreciation of the exchange rate. It was pointed out that monetary policy should not be driven by exchange rate developments, as a system of inflation targeting, not exchange rate targeting, was being operated. The opinion was also expressed that the current appreciation was linked with the influence of the global economy and was not necessarily a one-off and transitory shock.
In the context of the exchange rate, the Board turned its attention to the balance of payments. It was pointed out that recently it had been difficult to trace any link between the development of the balance of payments and the appreciation of the exchange rate, especially on the financial account, although the negative interest rate differential was now generating an outflow of portfolio investment.
The Board agreed that the pass-through of the growth in fuel prices and administered prices to other price categories was low. These pressures had so far been absorbed in large part by non-financial corporations. A surprisingly flexible supply response to changes in demand had been confirmed in the economy. Consequently, no major inflation pressures would emerge even if demand were to grow.
Some of the members drew attention to the forecast's over-optimistic assumptions regarding fiscal policy. The possibility of financing new expenditure using reserve funds could pose some upside risk compared to the forecast. The uncertainty surrounding the July elections might also be reflected in a rise in the risk premium.
The Board's discussion also touched on the rapid money supply growth and in particular the high growth in lending to all sectors of the economy.
The Board also turned its attention to monetary policy strategy. The prevailing view was that monetary policy should be forward looking and focus more on the long term. It was said that frequent adjustments to, and contrary movements in, nominal interest rates can destabilise the economy and in particular the investment decision-making of economic agents. Against this, the view was expressed that real, rather than nominal, interest rates are relevant to economic agents. The opinion was also expressed that the Board should not run the risk of a late monetary policy response to factors of monetary relevance. However, views were also expressed that trying too hard to fine tune monetary policy could be counterproductive.
After discussing the situation report, the Board decided by a majority vote to leave the two-week repo rate unchanged at 2%. Five members voted in favour of this decision, and one member voted for lowering interest rates by 0.25 percentage point.
Author of the minutes: Michal Hlaváček, Adviser to the Board
Please send any comments to the author at michal .hlavacek @cnb .cz