Present at the meeting: Jiří Rusnok, Mojmír Hampl, Vladimír Tomšík, Vojtěch Benda, Oldřich Dědek, Marek Mora, Tomáš Nidetzký.
The meeting opened with a presentation of the seventh situation report and the new macroeconomic forecast covering the horizon up to the end of 2020. Inflation had edged up to 2.4% in 2018 Q3. The overall inflation pressures in the domestic economy remained strong. This was due mainly to buoyant wage growth and continued growth of the real economy. At the same time, the inflationary effect of import prices had been restored, reflecting growth in foreign prices as well as the weakened koruna. The growth of the Czech economy had slowed in Q2. This had led the positive output gap to close slightly.
Inflation would increase further at the start of next year. In the subsequent period, however, the overall inflation pressures would ease owing to growth in interest rates, renewed appreciation of the koruna and a gradual slowdown in wage growth. Inflation would therefore approach the 2% target from above over the monetary policy horizon. The growth of the Czech economy would stay just above 3% this year and in the following two years. It would continue to be driven mainly by growth in household consumption and fixed investment. Fiscal policy would also contribute to domestic demand growth this year and the next. 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 balance of risks to the forecast at the monetary policy horizon as being slightly inflationary. The fundamental economic story was little changed from the previous forecast. The board members agreed that the main uncertainties pertained to the exchange rate of the koruna, which had been weaker than forecasted for some time now. In this context, the Board discussed the effect of global factors on the exchange rate of the koruna by comparison with surrounding regional currencies. The different nature of the koruna market due to “ overboughtness” of the Czech currency was mentioned. It was said repeatedly that the pass-through of the effect of the interest rate differential to the koruna’s exchange rate was currently limited, but that could change relatively quickly as domestic interest rates increase further. Against this, it was said that owing to the limits arising from the regulation of banks, which were curbing natural arbitrage trades, the effective interest rate differential might be much narrower than the monetary policy rate differential. Also discussed was the effect of the interest rate differential vis-à-vis the US dollar, which could be relevant to dollar investors in the context of normalisation of monetary policy in the USA.
In connection with the exchange rate, the level of domestic equilibrium real interest rates was also discussed. The consensus was that the real interest rate should not be negative in the current phase of the business cycle. One board member nonetheless warned that Czech rates were already quite distant from euro rates. In response, it was said that the CNB should pursue an autonomous monetary policy, especially in an environment where limited transmission of the interest rate differential to the koruna exchange rate allowed it to do so. Opinions were also expressed that the Board should not pay too much attention to exchange rate developments, as it did not target the exchange rate.
There was a consensus among the board members that, despite having slowed somewhat, the Czech economy was continuing to perform well and was characterised by a positive output gap. The labour market was still tight and wage growth was squeezing corporate profit margins. In addition, it was said that the wage growth might still have some inertia and might not slow as assumed by the forecast, and that this represented an upside risk to inflation. The procyclical behaviour of households, who save less in good times, was also mentioned. Growth would thus be driven mainly by household consumption together with investment in raising production efficiency, which firms would do under pressure from labour shortages and rapid wage growth.
Attention was then paid to the importance of keeping inflation expectations anchored. A large majority of the board members were inclined to the view that monetary policy should react to the long stay of inflation in the upper half of the tolerance band around the target by tightening the monetary conditions. In this regard, several of the board members could imagine a rate increase of 50 basis points. Nonetheless, a preference for a policy of small steps prevailed. It was said in the discussion that the external uncertainties had increased – the possibility of a hard Brexit and the growth in protectionist measures in global trade had been joined by the negotiations on Italy’s state budget. For one board member, this warranted a more gradual increase in rates.
At the close of the meeting the Board decided to increase the two-week repo rate by 25 basis points to 1.75%. The Lombard rate was increased by 25 basis points to 2.75% and the discount rate also by 25 basis points to 0.75%. Jiří Rusnok, Vladimír Tomšík, Vojtěch Benda, Marek Mora and Tomáš Nidetzký voted in favour of this decision. Oldřich Dědek voted for leaving interest rates unchanged and Mojmír Hampl voted for increasing them by 50 basis points.
Author of the minutes: Filip Novotný, Monetary Department