Minutes of the Bank Board Meeting on 2 May 2019
Present at the meeting: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda, Oldřich Dědek, Tomáš Holub, Aleš Michl.
The meeting opened with a presentation of the third situation report and the new macroeconomic forecast covering the horizon up to the end of 2020. Headline inflation had risen in 2019 Q1, reaching 3% in March. The growth in prices had been driven mainly by core inflation. Overall, however, the inflation pressures were no longer increasing. Besides a temporary fade-out of the inflationary effect of import prices, domestic sources of inflation were moderating as well. This was going on in a context of gradually falling wage growth and slower growth in economic activity. However, the Czech economy was still operating above its potential, while the positive output gap was gradually closing.
Inflation would be in the upper half of the tolerance band this year and would decrease to the 2% target over the monetary policy horizon. This would be fostered by a further tightening of monetary policy in both its exchange rate and interest rate components and by the fading out of the currently high growth in administered prices. The Czech economy would grow by 2.5% this year and pick up slightly next year. The increase in economic activity would be driven by all components of domestic demand. A markedly positive interest rate differential vis-à-vis the euro area and continued real convergence of the Czech economy would cause the koruna to firm gradually this year. Consistent with the forecast was an initial rise in domestic interest rates followed by broad interest rate stability until mid-2020.
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 broadly balanced. The board members identified risks stemming from developments abroad – in particular a more pronounced and potentially more protracted slowdown in economic growth in the euro area countries – as the greatest risks and uncertainties. The impacts of protectionist measures in global trade remained a source of external uncertainty. Uncertainty was also associated with the exchange rate of the koruna going forward. Some of the board members also mentioned risks arising from the domestic economy, specifically the risk of a positive fiscal impulse next year, higher growth in food prices and conversely a sharper slowdown in house price growth.
It was said repeatedly during the meeting that the new forecast provided a credible and consistent story. Despite having slowed in Q4, the domestic economy was growing in all its components, with household consumption and investment rising in particular. The labour market was assessed as still very tight and generating high wage growth. Although the domestic inflation pressures had now peaked, they would continue to manifest in inflation. It was said that by comparison with previous predictions, the fulfilment of the inflation target was not so dependent on rapid and significant appreciation of the koruna.
The biggest uncertainties of the forecast were still associated with developments abroad, the outlook for which was still moving towards slower growth. Some of the board members interpreted this as meaning that the unfavourable global sentiment was starting to be negatively reflected in real economic activity around the world. In this context, it was mentioned that the Czech Republic’s largest trading partner – Germany – is more sensitive than other EU countries to global developments. There was thus a risk that external demand would not recover this year as assumed by the forecast. The board members agreed that the risk associated with Brexit had been postponed to the future and that it was still impossible to rule out any scenario in this regard. This risk therefore did not have such a large weight in the current decision-making. The uncertainty associated with the impacts of protectionist measures in global trade persisted.
Part of the discussion was devoted to the exchange rate. The board members agreed that the uncertainty surrounding the exchange rate of the koruna was lower than it had been in the period following the exit from the exchange rate commitment. A model-based increase in the persistent component of the risk premium had also contributed to reducing the risk of the exchange rate following a different path than forecasted. On the other hand, it was said that the koruna was still being affected by the large positions established by investors when the exchange rate commitment was in place and that in an environment of strong risk aversion even a comparatively large interest rate differential would not necessarily lead to the koruna strengthening. In this context, however, it was also said that the weaker-than-forecasted exchange rate could offset the risk of slower external growth.
The risks stemming from domestic developments were viewed as less significant. It was said repeatedly that there was a risk of more relaxed fiscal policy next year. However, this risk was not substantial, since any increase in government spending would be offset by efforts by the government to seek additional tax revenues. Some of the board members expressed concern as to whether the current drought in Europe would lead to growth in food prices. The opinion was also expressed that house price growth could slow appreciably in response to the CNB’s previous macroprudential measures. This would foster a slowdown in inflation via imputed rent. On the other hand, it was said that the slowdown in house price growth would not be significant, as many properties are not bought on credit and the supply of housing was still very inelastic.
An alternative forecast scenario compiled using the new g3+ model was also discussed during the meeting. The new model was viewed by the Board as representing further progress in the CNB’s forecasting system, because the g3+ model better describes the complex functioning of a small open economy in the global context. It was also said that the alternative forecast scenario offered more intuitive paths of some variables, including the koruna exchange rate, and reduced the need for expert interventions.
The board members agreed unanimously that it was desirable to raise interest rates in the current situation. It was said that an interest rate increase of 0.25 percentage point could be interpreted as a fine-tune of the monetary policy stance reflecting the fundamental evolution of the Czech economy and the external environment. It was also said that this step would lead to further normalisation of interest rates. A rate hike would simultaneously contribute to the maintenance of financial stability, although the board members agreed that macroprudential policy should use its own instruments, which are more effective and better targeted than interest rates. Another opinion expressed in support of raising rates was that inflation, at 3%, had reached the very edge of the tolerance band around the inflation target. A majority of the board members agreed that the next interest rate movement could go in either direction.
At the close of the meeting the Board decided unanimously to increase the two-week repo rate by 25 basis points to 2.00%. The Lombard rate was increased by 25 basis points to 3.00% and the discount rate also by 25 basis points to 1.00%. Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda, Oldřich Dědek, Tomáš Holub and Aleš Michl voted in favour of this decision.
Author of the minutes: Jan Filáček, Monetary Department