Minutes of the Bank Board Meeting on 26 April 2007
Present at the meeting: Z. Tůma (Governor), L. Niedermayer (Vice-Governor), M. Singer (Vice-Governor), R. Holman (Chief Executive Director), P. Řežábek (Chief Executive Director), V. Tomšík (Chief Executive Director).
The meeting opened with a presentation of the April situation report and the new forecast for inflation and economic developments. The forecast took into consideration changes in the international environment, most notably the improving outlook for euro area economic growth, expectations of moderately higher rates in the euro area and the lower outlook for oil prices and external inflation. According the forecast the Czech economy had been fluctuating above the non-accelerating inflation level of output for six quarters. The growth structure had changed, with consumption and investment now being the engines of economic growth. Export and import growth rates were converging. Wages had ceased to be anti-inflationary. CPI inflation had stayed low in the first quarter and was slightly below the values forecasted in January. Adjusted inflation also remained low. The exchange rate component of the monetary conditions was neutral to slightly easy, while the interest rate component was slightly restrictive given the low inflation expectations. The monetary conditions were broadly neutral overall.
The growth outlook remained very good, the GDP growth forecast for 2007-2008 being 0.4-0.5 percentage point higher than in January. Pressures from the real economy would remain moderately inflationary at the forecast horizon. Growth in food prices and import prices would also be moderately inflationary compared to the January forecast. The inflation forecast was rising slightly in the near future compared to January, but as in the January forecast it lay in the upper half of the tolerance band of the inflation target at the monetary policy horizon. The prediction for inflation adjusted for the first-round impacts of changes to taxes, which is the key indicator for monetary policy decisions, was also rising slightly in the near future. Consistent with the macroeconomic forecast and its assumptions was a gradual rise in nominal interest rates over the entire forecast horizon.
After the presentation of the April situation report, the Board discussed the new forecast. It was said repeatedly that by comparison with January the April forecast suggested the build-up of a number of moderate inflationary factors, none of which alone presented a serious inflation risk, but the build-up of which was becoming an important factor in the decision on rates. However, it was also said repeatedly that the economic developments in 2007 Q1, which had seen atypical weather conditions, did not necessarily have sufficient information content to distinguish between short-term fluctuations and trends, hence it was too early to talk of a build-up of inflationary factors. In this context, the opinion was also expressed that the January and April economic outlooks did not differ greatly from each other. It was also said that current inflation was below the inflation target and the fact that it was measured using a new index was not relevant, as the new index had brought the consumer basket structure more into line with reality. It was also said that adjusted inflation, which chiefly reflects demand pressures in the economy, remained low.
The Board moved on to discuss the aforementioned factors and to assess the extent to which they could be described as inflationary. It was said that the external environment - for instance the increase in the euro area growth estimate, but also the latest data on higher oil prices than expected in the forecast - could become an inflationary factor. It was also said that the data on higher oil prices were out of line with the estimates of some analysts, who by contrast were pointing to increasing production capacities. It was also said that the inflation outlook for the euro area was more favourable than in January. The Board then discussed the extent to which the ongoing deregulation of rents and other administrative measures, including potential future measures associated with the planned fiscal reform, would impact on prices. It was said repeatedly that these factors might affect inflation expectations and subsequently pass through to wages and prices. But it was also repeatedly pointed out that this pass-through need not be significant and that this effect might be counteracted by the income effect and also the substitution effect via slowing consumption. The Board agreed that the planned reform could become an important factor for decision-making.
The Board then discussed the rate of economic growth and the link between the strong growth and the labour market. The Board agreed that the growth of the Czech economy would remain robust. The opinion was expressed that the growth estimate presented in the forecast might be too conservative given that a number of complementary indicators - such as retail wages and supply indicators - were suggesting faster growth in 2008 rather than the slowdown signalled by the forecast. It was also said that utilisation of production capacities was higher than in past years. In the context of the high rate of growth it was repeatedly said that current developments on the labour market would be relevant to future inflation. It was said several times that unemployment was coming down fairly rapidly and that this might signal the onset of wage inflation pressures. However, it was also said several times that strong competition, inflow of labour from abroad, capitalisation of labour and growing mobility on the labour market were putting the brakes on these pressures. It was also said that the fall in the unemployment rate was not surprising given the current rate of economic growth.
The Board also discussed the link between household consumption and other economic variables. Some of the board members pointed out that the growth structure was changing and that the role of private consumption was increasing. The relationship between interest rate changes and households' financial balances and the relationship between higher nominal incomes and the property market were discussed. It was also said that the favourable weather in the first quarter of this year had contributed to the rise in consumption. This was viewed as a supporting argument for the need to assess the inflationary factors over a longer period than three months.
At the close of the meeting, the Board decided by a majority vote to leave the CNB two-week repo rate unchanged at 2.50%. Four members voted in favour of this decision, and two members voted for increasing rates by 0.25 percentage point.
Author of the minutes: Kateřina Šmídková, Adviser to the Board
Please send any comments to the author at: katerina.smidkova@cnb.cz