Minutes of the Bank Board Meeting on 29 June 2006

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 June situation report, which assessed the new information and the risks associated with the April macroeconomic forecast.

Consumer prices had recorded higher annual growth in May (3.1%) than predicted in the April forecast (2.9%). The deviation had been due mainly to faster growth in administered prices and higher fuel prices in response to the evolution of world oil prices. An upswing in industrial producer price inflation chiefly reflected higher prices of energy-producing materials. Agricultural producer prices had been in line with the forecast in May.

The high GDP growth in 2006 Q1 had been in line with the prediction. Some deviations from the forecast had occurred in the structure of the economic growth. Household consumption had risen rather faster than forecasted, whereas government consumption had recorded a negative growth rate. Fixed investment had been in line with the forecast. The change in inventories had been considerably higher than expected. Conversely, net exports at constant prices had lagged behind the assumptions of the forecast. The available data from the labour market confirmed the favourable development of the economy. The unemployment rate in May had been 0.2 percentage points lower than forecasted. The higher demand for labour was starting to show up in a fall in the number of registered unemployed. The average nominal wage had risen 1 percentage point faster in 2006 Q1 than expected by the forecast.

After the presentation of the situation report, the Board began its discussion. The board members regarded the risks of the April forecast as being largely balanced and relatively low. Opinions were also expressed that the risks to inflation were skewed to the upside. The Board agreed that in line with the April forecast and current financial market expectations, there was a rising probability that the next interest rate movement would be upwards.

The Board's discussion focused on the factors that might affect inflation going forward. The domestic factors mentioned included the upswing in private consumption combined with the higher-than-predicted wage growth. However, the prevailing view was that risks of demand-pull inflation were not currently evident. Opinions were expressed that the higher wage growth was being offset by rising labour productivity. The risks were also limited because household consumption was still rising much more slowly than overall GDP. It was pointed out that in the situation of strong economic growth, manifestations of inflation pressures were being prevented by the simultaneously accelerating potential output, driven by the positive effects of foreign direct investment inflow.

The Board agreed that in the near future the inflation impulses would stem mainly from administered prices. A rise in bread prices would also have a one-off impact on inflation. Concern was expressed that inflation above 3% might affect inflation expectations. It was said that over the past year inflation in the Czech Republic had picked up much more than in numerous developing economies and in the euro area or the USA. On the other hand, it was argued that market participants would certainly take one-off measures and administered prices into account in the formation of inflation expectations.

The Board also discussed the external environment. It was said repeatedly that in the key economies inflation was rising moderately and interest rates were being gradually raised. The Czech Republic would probably not be able to buck this trend indefinitely. The widening of the negative interest rate differential might affect the exchange rate of the Czech koruna. In recent weeks its year-on-year appreciation had seen a correction.

The Board also discussed the prospects for economic growth in the Czech Republic. The majority of the board members were of the opinion that the current high growth rate is unlikely to be sustained in the longer term. In this context, attention was drawn to the risk of a deterioration in net exports, to the high rate of taxation and to the high degree of regulation and insufficient flexibility of the economy. The economic recovery in the euro area might help to maintain a higher growth path. It was also said that the future growth of the Czech economy and the perceptions of the prospects for the domestic economy by foreign entities depended on the launch of essential reforms.

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