Present at the meeting: Jiří Rusnok, Mojmír Hampl, Vladimír Tomšík, Vojtěch Benda, Marek Mora, Tomáš Nidetzký.
The meeting opened with a presentation of the fifth situation report and the macroeconomic forecast now covering the horizon up to the end of 2020. Inflation had increased slightly above the 2% target in 2018 Q2, among other things as a result of growth in the traditionally volatile prices of fuels and food. The Czech economy was above its potential output level. The stable growth of the economy was due mainly to household consumption, which was being supported by strong growth in households’ income. The continued investment growth reflected the positive evolution of domestic and external demand and firms’ efforts to streamline production amid labour shortages.
Inflation would be above the 2% target until the middle of next year and return to it at the monetary policy horizon. The overall fundamental inflation pressures remained strong and would rise even further in the short run, owing mainly to buoyant wage growth. At the same time, the anti-inflationary effect of import prices would halt temporarily, reflecting the koruna’s recent depreciation stemming from negative sentiment on global markets. In the subsequent period, however, the overall inflation pressures would ease owing to continued growth in interest rates, renewed appreciation of the koruna and slower wage growth amid further rise in labour productivity resulting from strong investment. The growth of the Czech economy would slow from last year’s high pace this year, but would remain above 3% in the following years. The economy would thus remain above its potential output level. The increase in domestic economic activity would continue to be driven mainly by robust growth in consumption and investment. After weakening temporarily, the koruna would return to an appreciation trend, although the adverse global sentiment would persist in the following two quarters. Consistent with the forecast was a continued rise in interest rates towards their long-run neutral level.
In the discussion that followed the presentation of the situation report, a large majority of the board members assessed the risks to the forecast at the monetary policy horizon as being balanced, while one board member identified the risks as slightly inflationary given developments in the domestic economy, especially wage growth. The board members agreed that the main uncertainties were the duration of the global factors which had recently caused the koruna to depreciate and growth in protectionist measures in global trade, including an escalation of the USA’s trade disputes with the euro area and other trading partner countries. At the same time, there was a consensus among the board members that the inflation outlook for the coming months in the area of food and fuel prices represented a short-term downside risk.
Some of the board members had perceived a qualitative change in the forecast and emphasised the shift in the forecast towards higher domestic inflation pressures as a result of the revision of growth in wages and labour productivity. A majority of the members were conversely of the opinion that the fundamental story of the Czech economy – despite the substantial revision of some of the figures in the forecast – remained broadly unchanged. The largest internal stress in the economy continued to be associated with the labour market and property prices. The inflation pressures nonetheless remained relatively subdued. A major change compared to the previous forecast related to the exchange rate, which had weakened mainly because of changes in global sentiment. It was said repeatedly that the forecast overestimated the effect of the most recent inflation observation on the predicted path. The board members nonetheless agreed that this uncertainty did not call into question the need to tighten monetary policy further.
The board members all agreed that it was desirable to raise interest rates. The purely mechanistic interpretation of the forecast was indicating a need for a more substantial rate increase of up to 50 basis points, whereas at the meeting arguments were made for gradually raising interest rates in smaller steps. The first of these arguments involved the risk of an excessive exchange rate reaction to a larger rise in interest rates. Another argument was that in an environment of increased uncertainty it was better to raise interest rates gradually and to wait for future economic data to become available before increasing them any further. Concerns were also expressed in the discussion that the market might view a larger rate increase as a panic reaction to the exchange rate developments and that such a step might be misinterpreted by the public as a sign that the CNB was targeting the exchange rate of the koruna rather than inflation.
The Board meanwhile agreed that the exchange rate was only one of two components of the monetary conditions that the CNB takes into account in its decisions. Moreover, the exchange rate is volatile and the CNB has only a limited influence over it, in the form of setting interest rates and communicating. It could only be welcomed that the normalisation of the monetary conditions would occur through a faster and more even increase in interest rates. The argument was also made that interest rates needed to be brought closer to their neutral level. It was also said that the increase in interest rates would have a positive spillover to macroprudential policy.
Part of the discussion was devoted to the speed at which the negative global sentiment would fade and what effect that would have on the exchange rate of the koruna. Although the forecast assumption that this effect would fade out over two quarters was based purely on expert judgement, most of the board members regarded it as acceptable. However, the opinion was also expressed that the exchange rate could return relatively quickly to stronger levels. The board members agreed that although the koruna market was still overbought, this fact was currently having no major effect on the behaviour of the koruna exchange rate, as the koruna had weakened to a lesser extent than the other Central European currencies.
At the close of the meeting the Board decided unanimously to increase the two-week repo rate by 25 basis points to 1.25%. The Lombard rate was increased by 25 basis points to 2.25% and the discount rate by 20 basis points to 0.25%. Jiří Rusnok, Mojmír Hampl, Vladimír Tomšík, Vojtěch Benda, Marek Mora and Tomáš Nidetzký voted in favour of this decision.
Author of the minutes: Jan Filáček, Monetary Department