Three questions: Could you please summarise the debate today, in particular the arguments used by the two members who voted for raising interest rates today. What were the counter-arguments that prevailed? This relates to my second question: Are we to infer from the debate and the vote that today’s decision is more of a technical break in rate normalisation? Or is it a longer-term trend? The third question does not relate directly to today’s meeting, but relates to the state budget for next year, which was approved yesterday. Could you please sum up what this budget means for the central bank in terms of its impact on the economy, inflation and, in turn, your monetary policy decision-making?
I will start with the first question. The debate was relatively long and rich. It wasn’t as clear-cut as had perhaps been expected. In the debate, we said that we are maybe at the start of a new phase in which the decisions about our next steps in potentially tightening monetary policy on the path towards neutral rates will to some extent be more difficult. Up to now, especially during this year, we were in a comfortable situation where we knew that the economy required higher rates for various reasons. We started very low, at zero interest rates, or slightly above zero if we’re talking about this year, and we had significant room where we couldn’t go wrong or go too far towards the neutral point. Now it’s clear that after the five increases this year, we have travelled part of that way. Of course, we don’t know exactly where the new normal, the new neutral point, lies, because it may have shifted after the crisis and after the use of all those unconventional monetary policy instruments. It probably now lies at a different point, perhaps a lower one, than it did before the crisis.
However, to answer your question more specifically, the colleagues who argued and voted in favour of a rate increase today basically used similar arguments as those presented at previous meetings in favour of increasing rates, i.e. the economy is still in a relatively expansionary mode, probably slightly above potential. There are signs of the labour market overheating. Inflation expectations are strongly anchored, as indicated mainly by core inflation and non-tradables, so there’s no need to worry that inflation has started to disappear. And they said: if we can do it, let’s do it, there’s nothing to wait for. The other group – eventually the majority – said: yes, the direction for the future is probably clear, but on the other hand there’s no hurry. We’re under no urgent pressure to raise rates quickly. We’ve already done a considerable part of the job as regards this year. There were arguments which said, yes, the domestic economy would probably justify it, but let’s not get too fixated on the new normal or the neutral level, as the environment around us is still abnormal to a large extent. That means, above all, the still expansionary monetary policy stance of the ECB and other European central banks.
So, the debate was basically about whether we can take a break with a clear conscience – we’ll see for how long – and wait and see how the situation develops, how some things among the accumulating uncertainties abroad perhaps become clearer, what the new data from the Czech economy will look like, whether some things were just a temporary swing – for example inflation, where the latest figure was surprisingly low. However, we know that this was due mainly to food prices, which are usually very volatile and difficult to forecast, as a few key commodities can significantly affect the whole item. They are often affected not only by domestic factors on the demand side, but also by sizeable external factors which play a role on the food market. So, we’ll see.
Some members – in the end the majority of them – preferred to wait for the new data and the new forecast, stressing that today we are under no urgent pressure to raise rates quickly due to large inflation pressures or dramatic overheating. The arguments from the real economy speak more in favour of waiting, because we see some signals of a slowdown, a slight cooling. However, it’s in the direction which we anticipated and which we basically welcome, because before that, the economy was overheating more than it may have seemed. So, that’s my summary of the debate. I’m sure my colleagues will be ready to elaborate on it later, as I certainly don’t remember all the details.
Your second question was about the “technical break”. We’ll see. What we’re saying is that if the situation develops as foreseen by the current forecast – we’ll have a new forecast in February – there will actually be a longer break. However, the forecast assumes appreciation of the koruna – we can say a visible or sizeable one compared with the previous half-year. So that’s still within our field of vision – both components of the monetary conditions, including the exchange rate. But I should stress that the exchange rate isn’t primary to us. We don’t target the exchange rate. We aren’t at all nervous, because it is more stable and appreciating more slowly. We can explain a number of the reasons, but at the same time we’ve had no strong reason so far to question this forecast. We’ll see, of course. There’ll be a new forecast and that may be set slightly differently.
As regards the state budget and public finances, our calculations and estimates indicate that there will be some fiscal expansion in both 2018 and 2019. We estimate the contribution of the fiscal impulse to GDP growth at around 0.5%, and 0.4% next year. So, there’s a slight fiscal impulse. It’s an argument pointing to slightly higher inflation, let’s say, but to no fundamental degree. With regard to how we perceive macroeconomic equilibrium, this is nothing dramatic. Our public finances will still be in surplus, and in this regard there’s no pressure for any extraordinary monetary policy activity.
Could you please evaluate 2018 as a whole in terms of monetary policy and its impact on the koruna, and also on mortgages, because there was a series of measures and rate increases. Were they sufficient? Or is there still room for them to continue next year? And will banks comply with those limits?
To start with monetary policy, we were very active in this respect. There were five increases in key interest rates of 0.25 percentage point. That’s a big qualitative change compared with the start of the year and the period before the start of 2018. As I said, we’ve travelled a long way towards that “neutral” point at which monetary policy is neither supporting nor cooling the economy. We’re still in the expansionary mode to some degree. We’re not at the neutral level yet. We don’t know precisely where that lies, but let’s say it’s somewhere between 2.5% and 3%. So, our support for the economy is only very moderate in this sense. In my opinion, this was an appropriate response to the evolution of the Czech economy, I’m glad we did it. In this regard, we differ quite a lot from the rest of the world, with the exception of our colleagues in the USA and Canada. We were third off the blocks, so to speak, and we are also third at the checkpoint on the path towards a neutral and normal rate level. I think we reacted in time and appropriately in this regard. By doing so, we also ensured price stability, which is of key importance to us. Our primary mandate is to maintain price stability at the level of our inflation target, which is 2%, or around it, and we are fulfilling that.
As regards macroprudential policy measures, i.e. measures relating to housing loans and bank capital, we were relatively active in that area as well. As you know, in addition to the LTV limits introduced earlier, in October this year we launched limits defining the degree of indebtedness of those who borrow to buy property – DTI and DSTI. I believe banks will stick to those limits, because it is, after all, in their interest. It’s no arbitrary decision on our part to prescribe such limits. We do it so that our banks are ready for the worse times which may come, do not take on excessive risks and do not accept too heavy a burden that will then manifest itself fully at a time of weaker economic growth, which may also come one day. So, we were active in this area as well. In addition, we decided to further increase the countercyclical capital buffer rate, which forces banks to withhold part of their earnings to top up their capital, again for worse times. I’m also glad about that, because I regard it as a very important preventive measure for the stability of the Czech financial sector. As to whether it will be enough – I think it will do for now, as far as macroprudential measures are concerned. We’ll see. It will be possible to assess these things sensibly in about a year, i.e. sometime in November next year we’ll have roughly twelve months of data. And then we’ll see about mortgages. I’d like to ask that the sometimes very emotional statements of the parties involved, i.e. above all developers, but also credit intermediaries, be discounted a little. I understand that this is restricting their business a bit, but it’s our role to take such sometimes unpopular decisions. It’s in the interest of the majority, in the public interest, to maintain the stability of the Czech banking sector at the highest possible level.
As for the monetary policy stance, I commented on that in my previous answers. I think we are trying to be flexible there. This certainly isn’t the end. If the economy develops favourably, which we continue to expect – the Czech economy could grow by around 3% next year – a further interest rate increase will probably be necessary. But it will certainly be much more gradual than this year.
I would like to ask about the global risks, specifically Brexit. Is it already incorporated into your models?
Brexit certainly isn’t incorporated explicitly into our models in detail, because we can’t do that. Nobody knows what form the exit will take. We all assume that the UK will leave the European Union sooner or later, but I think nobody is able today to estimate the details of the timing and execution. I venture to speculate that I wouldn’t expect any drastic impacts on the Czech economy over, say, the medium term. Yes, there may be unexpected complications in the short run, in the order of a few months, but the Czech economy will cope with that. In the medium term, it’s in the interest of everybody involved, both the UK and the EU, to reach a solution that will have as little negative effect as possible on mutual trade. That’s the key thing for us. It is basically impossible to incorporate that into the model today.
Together with the previous forecast, the CNB published a sensitivity scenario for the exchange rate which assumes that a lower exchange rate level would lead to a need to increase rates 80 to 90 basis points more than the baseline scenario assumes. The koruna is slightly weaker than the baseline scenario. However, you mentioned a number of especially external factors which are in fact acting in the opposite direction. In the opinion of the Bank Board, are the external factors acting so much in the opposite direction that the path of the koruna in the sensitivity scenario would not imply a need to raise rates. Or is it just making the necessary increase much smaller?
This was an important part of today’s debate – how to quantify and estimate these factors, which to some degree offset each other. You’re indeed right in that we still, on the one hand, seem to be on the side of the sensitivity scenario of the current forecast, the scenario with a weaker koruna. On the other hand, there are new anti-inflationary factors coming particularly from the external environment which dampen this. So, yes, I expect the new forecast to bring a change in the calibrations of these factors acting together in the sense you’ve mentioned. That means that even in the potentially materialising sensitivity scenario, the scenario with a weaker koruna, rates may need to be raised less than we assumed in the original and still valid November forecast.
Two questions. How do you view the declining forecasts for the euro area? Do you see them as a negative signal now? The second question concerns the flattening yield curve. How do you assess the rate of this flattening? Would it be relevant if considerations such as “a flatter yield curve implies a risk” appeared in our environment, as they have in the USA, for example?
We are, of course, carefully monitoring the slightly worse outlooks for the euro area. We partly incorporated them into today’s considerations, but the new estimates will be fully reflected in the February forecast. They represent a moderate anti-inflationary argument for us. However, we don’t think for now that this means a major turnaround in trends that will fundamentally affect the Czech economy, as in my opinion even in the euro area it’s not certain now how things will evolve in the coming quarters. There are some signs of a slowdown. However, this is not something we hadn’t quite expected. The question is the extent of the accumulating risks or uncertainties, as they are building up. An accumulation of risks always implies an increasing risk overall, because the likelihood that it will materialise rises and the potential impact intensifies. If there are more risks, they start to merge and multiply. So, yes, this is part of our considerations, but we certainly see no catastrophe there for now.
As regards the flattening yield curve, we are of course monitoring it. Yes, it might seemingly nominally be an indicator of an economic trend. However, I wouldn’t overestimate it. I don’t think we currently have enough other necessary evidence to draw that conclusion from it. Moreover, we are still – as to some extent are the Fed and the Canadian central bank – in a phase soon after the termination of non-standard tools such as quantitative easing and, in our case, the exchange rate commitment, and the behaviour of some parameters of the financial world might have changed a little. We cannot mechanistically derive the same conclusions from it as those possibly valid for the past which we already know and can thoroughly analyse. So, the flattening of the yield curve itself points to some growth in uncertainty as regards the future – the longer-term future. But it is no evidence that a major turnaround in the economic trend will occur very soon.
Did you discuss at today’s meeting the year-end effect caused by the resolution fund, which in the past few years has weakened the koruna and pushed short-term interest rates to negative levels before the year-end? Is it a factor making the future path of the koruna unclear now? Did you discuss the fact that the year-end effect is surprisingly not quite as strong as it was in the previous two or three years? The koruna has been strengthening in the past few days, which it did not do in previous years, and short-term rates have returned from negative to slightly positive levels. Do you have any explanation for this?
We discussed this. Our colleagues prepared very interesting documents which also partly deal with this and explain to us some minor anomalies in the behaviour of the transmission mechanism and, among other things, the behaviour of the koruna. The exchange rate is always a little mysterious and we will never fully understand it. But we do understand some things better now, or at least we think we do. You’re right in that we are saying that the year-end effect is much more moderate than in the past two years. The explanation is difficult to verify, but perhaps market agents have become a little accustomed to this. It is no longer a new thing they have to deal with at the very last moment. They all somehow anticipated it and somehow adapted to it in advance. So the effect may not be so strong, although there is probably some. Generally, we are saying that it is not just the specific reason we’re talking about that is playing a role, but the year-end is always a little different than most of the year. Traders’ activity is much lower. The market is even shallower than usual. This is normal. We did not discover anything special and we felt no need to do so. This was definitely one of the small – perhaps technical – points in the discussion which tells some of us that, for these reasons as well, it’s perhaps better to wait for the start of next year, which will show us to what extent these were exceptional phenomena at the year-end and to what extent it’s a fundamental trend.