Minutes of the Bank Board Meeting on 6 February 2020

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 first situation report and the new macroeconomic forecast. According to the forecast, headline inflation would be above the upper boundary of the tolerance band for most of this year and would fall close to the CNB's 2% target over the monetary policy horizon. Consistent with the forecast was a rise in domestic market interest rates initially, followed by a decline in the second half of this year.

A majority of the board members assessed the risks to this forecast at the monetary policy horizon as being balanced. The future exchange rate path was identified as an anti-inflationary risk to the forecast. The external assumptions of the forecast continued to include the risk of a potential slower recovery of external demand growth. Potential higher inflation due to stronger domestic inflation pressures was seen as an upside risk to the forecast.

A large part of the meeting was devoted to discussing the risks and uncertainties stemming from the external environment. A majority of the board members agreed that the uncertainties associated with the UK's withdrawal from the EU and the impacts of protectionist measures were substantially smaller than in the past, although they could return to the fore in the course of the year. By contrast, Tomáš Nidetzký still saw these uncertainties as high, saying that the form of trade cooperation between the UK and the EU remained unclear and a review of US-EU trade relations might start now that the US-China trade war had calmed down.

A majority of the board members expressed some doubts about the intensity of the external growth recovery expected by the forecast this year. The available preliminary figures on economic growth in some euro area countries were indicating a continuing slowdown in the fourth quarter of last year. However, as Tomáš Holub pointed out, these figures may have been distorted by extraordinary events such as the strikes in France. Doubts were repeatedly expressed as to whether the optimistic outlooks and favourable sentiment indicators could be relied on in a situation where the available hard economic data were not indicating a turnaround in the euro area business cycle. In this regard, mention was also made of the current decline in global crude oil prices as a generally negative signal about the global economy going forward (Tomáš Nidetzký).

The board members agreed that the Chinese coronavirus epidemic was a completely new external uncertainty, but their views of this uncertainty differed in intensity. Tomáš Nidetzký and Oldřich Dědek emphasised the potential impacts of the epidemic on the global and Czech economy, while the rest of the Board had a less intense view of this risk.

Opinions were repeatedly expressed in the debate that structural changes were going on in the Czech economy. As Marek Mora pointed out, the share of non-export sectors such as services and construction was increasing. Shrinking dependence on exports coupled with growing geographical diversification of exports (Vojtěch Benda) was leading to the domestic economy not responding as sensitively to changes in demand in the euro area as in the past. Another structural change debated was the greater lag in the response of the domestic labour market to the slowing growth in real economic activity than had been observed in the past. The labour market was meanwhile still assessed as strongly overheated. Similar structural changes were probably also going on in some other European economies (Jiří Rusnok and Marek Mora).

The Board discussed in depth the inflation forecast for the next few months, which was expecting inflation to rise further to as high as 3.7% in April. The Board agreed that the bulk of the forecasted rise was due to the one-off effects of increases in indirect taxes, administered prices and food prices. In this context, Oldřich Dědek pointed out that core inflation remained at 2.5% and its short-term outlook was stable. However, some of the board members - Marek Mora, Vojtěch Benda and Tomáš Holub - expressed concerns about the possible growing upward effect of demand-pull inflation pressures on food prices and prices in other categories, which would affect headline inflation at the monetary policy horizon as well.

As in November, the Board debated the risk of a potential weakening of the anchoring of inflation expectations in a situation where inflation had been well above the CNB's target for an extended period of time. A majority of the board members agreed that this risk was small but should not be completely discounted. Vojtěch Benda mentioned that the CNB should do everything to ensure that the period of high inflation did not last long and inflation quickly returned to the inflation target. Together with Tomáš Holub, he was of the opinion that raising interest rates at this meeting would help support the anchoring of inflation expectations.

The appreciation of the koruna in late 2019 and early 2020 was also discussed in detail. The current exchange rate at the time of the meeting was slightly stronger than forecasted. Marek Mora, Oldřich Dědek and Aleš Michl expressed doubts about the exchange rate stability assumed by the forecast this year. These members felt that in an environment of falling inflation, the domestic price level would converge to that in the euro area through nominal appreciation of the koruna as well. A majority of the board members meanwhile felt there was a risk of a stronger koruna, but not in the spirit of the sensitivity scenario of a rapid fade-out of negative global sentiment.

Part of the meeting was devoted to fiscal policy and the risks stemming from this area. The incorporation of new information about the rise in the minimum wage ordered by the government and about the approved increase in parental allowance, coupled with the already previously expected effect of the above-average increase in pensions, was leading in the forecast to a brief surge in domestic inflation pressures at the start of this year. Jiří Rusnok, Marek Mora and Tomáš Holub felt there was a risk that similar fiscal measures could continue to come, especially given the elections to the lower house of parliament next year. This would represent an upside risk to the inflation forecast at the monetary policy horizon.

In the discussion, it was said that current decision to increase rates by 25 basis points could be viewed as just a fine-tune of monetary policy (Jiří Rusnok) and that if the increase had not occurred at this meeting it would probably have happened at one of the next monetary meetings (Tomáš Nidetzký). On the other hand, Oldřich Dědek said that the previous interest rate increase was enough and that a further rise could harm the real economy, which now faced negative impacts from the economic slowdown abroad. Aleš Michl added that economic growth does not die of old age, it has to be killed by something, and he did not want that something to be tighter monetary policy at a time when Czech suppliers in industry were in recession and holding back wage growth. He recommended being prepared for both eventualities - an unexpected crisis and an unexpected strong economic recovery - and he would then choose a rate cut or rate hike accordingly.

At the close of the meeting the Board decided by a majority vote to increase the two-week repo rate by 25 basis points to 2.25%. The Lombard rate was increased by 25 basis points to 3.25% and the discount rate also by 25 basis points to 1.25%. Four members voted in favour of this decision: Jiří Rusnok, Marek Mora, Vojtěch Benda and Tomáš Holub. Three members voted for leaving interest rates unchanged: Tomáš Nidetzký, Oldřich Dědek and Aleš Michl.

Author of the minutes: Jan Filáček, Monetary Department