Minutes of the Bank Board Meeting on 25 September 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 sixth situation report assessing the fulfilment of the forecast contained in the fifth situation report in the light of the newly available information. So far in Q3, headline inflation had stayed very close to the upper boundary of the tolerance band around the CNB’s 2% target. It had meanwhile been slightly above the forecast. The deviation from the forecast had been caused predominantly by higher core inflation, with faster growth in food prices and a smaller decline in fuel prices contributing to a lesser extent. In 2019 Q2, GDP growth had continued at a roughly unchanged pace, in line with the forecast. Some demand components had deviated partially from the forecast. The new data for Q2 and part of Q3 were meanwhile signalling continued solid economic growth. Wage growth had eased rather more slowly than expected. Amid labour shortages, growth in employment had slowed further, while the unemployment rate had stabilised. The overall message of the new labour market and economic activity data was broadly neutral with respect to the current forecast. The koruna had been weaker-than-forecasted in Q3. Expected producer price inflation in the euro area had been revised down substantially in the update of the outlook for foreign variables. A more detailed discussion of the risks to the current inflation forecast can be found in the commentary on the Graph of Risks to the Inflation Projection (GRIP).

In the discussion that followed the presentation of the situation report, a large majority of the board members assessed the risks to the current inflation forecast at the monetary policy horizon as being rather substantial in both directions and slightly inflationary overall. The weaker-than-forecasted koruna exchange rate in Q3, which may persist, was fostering higher inflation and interest rates. The inflationary effect of the exchange rate was being partly offset by a decrease in expected industrial producer price inflation in the euro area. In addition, the risk of a more pronounced slowdown of the external and, in turn, domestic economy still persisted. The impacts of protectionist measures in global trade and a disorderly Brexit remained sources of uncertainty.

A large part of the debate was devoted to examining the extent to which the external situation had converged towards the sensitivity scenario of lower external demand contained in the previous situation report. There was a consensus that the external slowdown was not very visible in the domestic economy yet. Besides continued robust growth in household consumption, this was probably due to the gradual reorientation of the Czech economy towards higher-value-added production. At the same time, one board member pointed out that in the past, the outlooks for external GDP and industrial producer prices had worsened only gradually in downward phases of the business cycle and had initially underestimated the depth and length of the impending downturn, and that this could be the case now, too. The domestic economy was meanwhile benefiting to a large extent from a positive fiscal impulse, whereas the contribution of private investment was falling and the export-oriented part was stagnating or growing only slowly. It was also mentioned several times that the positive factors in the domestic economy were so far able to offset the negative – though currently only modest – external shock. However, any drop in external demand would certainly show up in the Czech economy in time.

The exchange rate, which, owing to global factors, was holding just below 26 koruna to the euro and was thus weaker than forecasted, was also discussed in some depth. It was said repeatedly that a non-strengthening exchange rate can be a welcome automatic stabiliser amid slowing growth in external demand and weakening external inflation pressures. At the same time, however, one board member saw the weaker exchange rate as a potential inflationary risk going forward if the price impacts of the depreciation were to outweigh the anti-inflationary effect of the domestic economic slowdown. It was also said that the exchange rate could be expected to stay at its current levels in the short term and appreciate only slightly in the longer term. And even a higher interest rate differential would not be reflected in higher demand for the koruna.

Part of the debate was devoted to the question of the interpretation of fulfilment of the 2% inflation target and the credibility thereof in a situation where inflation had been close to the upper boundary of the tolerance band for several months. One bank board member preferred to make full use of the tolerance band and to regard inflation close to the upper boundary of the band as fulfilment of the target. Against this, it was said that the best way of targeting was to try to steer inflation towards 2%. As a result of various shocks, inflation could diverge temporarily from the 2% target and, as the case may be, move outside the tolerance band for a short time. It was nonetheless pointed out that a breach of the 3% upper boundary of the tolerance band would be hard to explain to the public. In this regard, the opinion was expressed that monetary policy should have reacted more actively in the past, thereby steering inflation to the 2% target and enhancing its credibility. It was said repeatedly that inflation expectations were still well anchored in the Czech economy and there was no risk of a loss of credibility. This applied particularly in the current global context, where the key central banks were worrying about undershooting their inflation targets and some had already eased monetary policy.

Some of the board members mentioned the decline in domestic fixed investment and the revision of past national accounts data. It was said that both investment and related lending activity had weakened considerably over the last year. This may have been linked with a drop in sentiment in manufacturing, which could negatively affect overall economic growth going forward. The board members agreed that uncertainty of firms linked with the external environment was probably playing a large role. The next forecast would assess whether the low investment growth amid labour market tightness was an inflationary factor acting via lower productivity growth or would conversely be anti-inflationary, against a background of weaker growth of the entire domestic economy as a result of declining external demand.

In light of the slightly inflationary overall balance of risks to the forecast, the Board discussed the possibility of raising interest rates. A majority of the board members noted the complexity of the situation and weighed between keeping rates unchanged and increasing them. According to one member, inflationary risks were materialising, especially in the case of the exchange rate, and should partially be suppressed by tightening monetary policy. According to that member, the inflationary factors would fade away after a while and be outweighed by anti-inflationary effects, which would conversely be offset by a future easing of monetary policy. Another member also favoured raising interest rates, mainly on account of the credibility of fulfilment of the inflation target. Conversely, doubt was expressed about the forecasted interest rate path, i.e. a rise in rates at the end of this year followed by a fall in the first quarter of next year. Another argument made concerned the understandability of the central bank’s actions in a situation where the financial market, under the influence of recent CNB communications, did not currently expect a rate change. Another two members also pointed to the predictability of the Board’s decision. The opinion was also expressed that a rate hike would only affect the short end of the yield curve and would increase firms’ operational financing costs. A preference for keeping interest rates unchanged in a situation of elevated uncertainty ultimately prevailed among a majority of the board members. Nonetheless, the Board expects to return to this debate at the next monetary meeting, when a new forecast will be available.

At the close of the meeting the Board decided by a majority vote to leave the two-week repo rate unchanged at 2%. Five members voted in favour of this decision: Jiří Rusnok, Tomáš Nidetzký, Oldřich Dědek, Tomáš Holub and Aleš Michl. Two members voted for increasing the rate by 0.25 percentage points: Marek Mora and Vojtěch Benda.

Author of the minutes: Jan Syrovátka, Monetary Department