Transcript of the introductory statement from the press conference
23rd June 2010
GOVERNOR
As you’ve been told, I said that I would give you a very brief overview of monetary policy during the period I’ve spent at the central bank, so this should be illustrated by this chart with the evolution of inflation. However, although we didn’t coordinate this in any way, today after the Bank Board meeting my colleagues gave me a similar chart on this T-shirt, so you can have a look at it – this is the evolution of interest rates, the repo rate, over the 12 years, so this nicely complements the evolution of the inflation rate, so if you need to check where the rates were at that period, I can show you.
I’ve prepared this chart because when you look back at those 10 to 12 years, it’s useful to realise that many things have changed since then. I came to the central bank shortly after our predecessors decided to adopt inflation targeting, so one could say that I’ve been here almost from the very beginning of inflation targeting. Of course those of you who have watched us for a longer time remember that the monetary policy framework and inflation targeting framework has developed gradually, so I just wanted to recapitulate some of the key moments.
We started with a completely different level of inflation: here you can see that in 1998 it was even in double digits. Similarly, interest rates were still relatively high. At that time, in the late 1990s, a large decline in inflation occurred. However, it wasn’t connected only with inflation targeting and the switch to a different monetary policy regime; a number of other factors combined at that time, for example, a very rapid decline in oil prices, agricultural prices and so on, so inflation fell very quickly. So this led to the first – but not last – undershooting of the inflation target. The framework also changed because, as you can see, after a few years we switched to targeting headline inflation. At the beginning it was net inflation, and just to remind you, the reason was that still a relatively large proportion of the consumer basket was regulated, which is obviously something beyond the reach of monetary policy, so that’s why the targets were set in terms of net inflation at the beginning. Another important reason was that the targets were set as at year-end. After several years’ experience, we came to the conclusion that we needed to indicate an ongoing pressure towards the fulfilment of the inflation target, that it isn’t just a one-off hitting of the target at the end of the year, discussing only at the end of the year whether or not the inflation target has been hit, but that the characteristic feature of inflation targeting is that the central bank continuously tries to bring inflation back to the target if the expected inflation path deviates noticeably from the target.
Later there was another important moment connected with an amendment to the Act on the Czech National Bank, related to its independence, because there were some articles that were eventually found by the Constitutional Court to be in contradiction with the principle of central bank independence. One of these things was an agreement with the government on the inflation target, so at one point in time we defined the inflation target together with the government, but it wasn’t a very big problem and we reached an agreement relatively quickly. Later we also started to publish the numbers of votes cast, so we disclosed the ratio of votes cast by the Bank Board members, so this was a step towards greater transparency. More such steps followed, they were also connected with the introduction of an unconditional forecast, which means that our forecast already contained the reaction of the central bank. I don’t know, looking around I’m not quite sure now if any of you went to our press conferences in the first half of the decade, but you may remember that after our decisions, when for example we cut rates, I was often asked if our forecast was still valid, because we changed rates and at that time, before 2003, the forecast assumed unchanged interest rates, so a change in rates meant that the economic outlook would also be affected, so this was a great contribution of an unconditional forecast. Again, this was a step towards greater transparency.
I think the first big test of the inflation targeting framework of monetary policy came in 2002–2003, when there was a large effect on appreciation, a large pressure on appreciation, with the koruna strengthening very rapidly. In this sense we found ourselves under pressure, we opted above all for rapid interest rate cuts, but in the end we also used interventions and as you may remember, the overshooting in the direction of excessive appreciation of the koruna subsided and a correction in the exchange rate took place. Since then, just to remind you, we haven’t had to carry out foreign exchange interventions.
At that time we also switched to a declining band, which we used to get to a situation we could call price stability and in this sense, as you can see, the framework has been stable since 2006 with a point target. We also had many discussions about what is better, defining a band or a point target plus or minus a tolerance interval. Gradually, in the second half of the decade, we also started to publish an interest rate trajectory, which is connected with, and can’t be done without, an unconditional forecast, because you need to have the monetary policy reaction built in the prediction.
Like other central banks, during the crisis we discussed how to respond above all to the frozen financial markets, so we prepared some instruments, fortunately we didn’t have to use them very much, but we tried to be ready for emergency situations. Another year later we also started to publish the exchange rate prediction, which is still a relatively rare thing. So far the experience has been good. Again, from the point of view of communication, I was asked very frequently about the exchange rate when we published our forecast. The fact is that in an open economy the exchange rate plays a major role, so although we don’t have any explicit or implicit target for the exchange rate, it is a very important variable. We solved it this way, because we now say that the best we can tell you about the exchange rate in the medium term can be found in our prediction.
Of course, currently there are a number of topics on the table that concern the monetary policy framework. One of the big topics is the relationship between financial stability and monetary policy and if the financial stability area can give specific recommendations to monetary policy, how to incorporate information from the financial stability area into the process of monetary policy decision-making. What we have done so far is that we have a “macro-financial panel” before the Bank Board’s monetary policy meeting, if we have a new forecast, four times a year, and we receive, the Bank Board receives various information from the financial markets, so this involves presentations not only from financial stability experts, but also from the Financial Markets Department, directly from the markets, or we ask for selected topics to be analysed. So we have the information at our disposal, the question is whether it should be somehow directly integrated in the monetary policy framework.
My last remark on the particular developments in inflation, you can see that we were often below the target, or above the target. We are an open economy, various shocks occur. You can see it here in 2003, the explanation is clear, I have mentioned it, a large appreciation pressure on the exchange rate and monetary policy, if it is not to make other variables volatile, is not strong enough to offset such shocks in the short term, so the return to the target can be very slow.
On the other hand, in 2008, it was the effect of changes to regulated prices that resulted in the overshooting and again it is something that monetary policy makers must be able to explain why they seemingly didn’t respond in an adequate way to the level of inflation observed at that time.
Subsequently, a very fast correction in the aftermath of the crisis, so we were below the target for some time for a change. We are now in the tolerance band around the point target and I assume, we assume, the forecast assumes that we should get into the area around the point inflation target towards the end of the year.
Whereby we move smoothly to our today’s decision-making. You already know that we decided to leave our limit 2W repo rate at the current level, that is 0.75%. We assume that at the monetary policy horizon, that is four to six quarters, we will be close to the inflation target of 2%.
There were no major changes since the last Board meeting on monetary policy issues that would change the message of the forecast or the message of the risks. We regard the risks as being relatively balanced. They go, as usual, in both directions, but there are no significant risks in either direction.
Just to remind you, you can see here the current inflation forecast. If we look at the comparison between the latest Consensus Forecast and the forecast, the picture is a bit mixed, we might say very slightly anti-inflationary. The most significant anti-inflationary factor is the development of the EURIBOR rates, which is the last part of this chart, so you can see that the expected rise in interest rates in the euro area is being postponed and, of course, given our close link to the euro area, it has a relatively strong effect on us, too. Similarly, you can see no major change in consumer prices, so we can say a relatively small change, or, if any, rather in the anti-inflationary direction. As for oil, the downward shift is offset, in turn, by the exchange rate, that is the appreciation of the dollar, so these two changes counteract each other.
In the domestic economy, factors going in opposite directions. GDP growth is surely slower than we would have expected. On the other hand, it is confirmed that the Czech economy is going up, the recovery is taking root, we will see what the further developments will look like. Of course, there is, I repeat again, a strong link to the situation of our major trading partners. The same can be said about the developments in manufacturing and retail sales.
Of course, we expected that the household sector cannot be expected to foster significantly the current recovery in the Czech economy. The pressure on the real economy is still relatively significant, which is reflected in employment, unemployment, and, of course, the closely related wage growth and this is one of the factors that can be marked as anti-inflationary.
Here we can see the recent developments in comparison with our forecast. As I said, there are no dramatic changes, a slightly inflationary effect of slightly higher-than-expected inflation; on the other hand, the anti-inflationary effect associated with lower wage growth and also lower-than-expected GDP growth, as I said.
Finally, the main risks to the forecast. I repeat what was said at the beginning, we regard them as being broadly balanced. I have mentioned external developments, the EURIBOR rates in particular, as probably the most significant anti-inflationary risk. We have mentioned and seen the developments in the real economy on the labour market. As for inflationary risks, we can mention the exchange rate of the koruna, which is somewhat weaker than we expected but it is no major difference. Similarly, slightly higher-than-expected inflation. So, the risks are balanced but this time relatively slight risks. The risks that are currently probably difficult to map are external developments and the developments in the euro area.