Minutes of the Bank Board Meeting on 7 May 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 third situation report and the new macroeconomic forecast. According to the forecast, headline inflation would decline rapidly into the tolerance band in the next few months and would be close to the CNB’s 2% target over the monetary policy horizon. After the sharp fall in domestic market interest rates recorded in March, consistent with the forecast was a further decline in 2020 Q2 followed by broad stability.
The Board assessed the risks to the forecast in the current extraordinary situation as being unprecedentedly high and requiring an even greater easing of the monetary conditions compared with the baseline scenario. In the current situation, the risks were primarily connected with the course of the pandemic and especially with the duration and size of the impacts of the quarantine measures on the global and Czech economy.
The board members agreed that the current economic situation and the baseline forecast scenario were subject to an immense degree of uncertainty in both the local and global economy. There was a consensus that there could be big structural changes in the economic environment and in society as a whole. This would have impacts on the growth or level of potential output. In this context, Jiří Rusnok and Marek Mora drew attention to the division of the economy into different types of sectors and industries. On one side were those that would fare better, such as manufacture of medical equipment, online shops and digital communication platforms. On the other side were those that would fare worse, such as transport and tourism and accommodation, catering and restaurants. It was also said repeatedly that these structural changes could last a very long time. The only fundamental breakthrough capable of reversing the trend would be the development of an effective and affordable vaccine (Jiří Rusnok, Aleš Michl). Until such time, COVID-19 could return. The Board therefore welcomed the fact that a longer-lasting pandemic scenario and a pandemic resurgence scenario had been drawn up along with the baseline scenario. With regard to these scenarios, a majority of the board members said repeatedly that following the unprecedentedly large contraction recorded in the current quarter, there was considerable uncertainty associated with the assumptions made about the form and timing of the subsequent phase of renewed economic growth. The recovery was unlikely to be as quick and easy as originally assumed. Aleš Michl additionally noted that economic growth had already been slowing before the onset of the pandemic. Marek Mora and Tomáš Nidetzký pointed out that other sources of uncertainty included the situation in the euro area as a whole in the wake of the German Federal Constitutional Court’s verdict on ECB monetary policy, and the risk of a continued trade war between the USA and China.
The next part of the Board’s debate focused on the uncertainty concerning the exchange rate. In this context, the board members discussed the risk of the koruna depreciating in response to a larger interest rate cut than the financial market was expecting. There was a consensus that much of the recent sizeable depreciation had been due to negative market sentiment. The financial market situation had recently calmed somewhat, but it could still be regarded as a fragile equilibrium (Tomáš Nidetzký, Tomáš Holub). The currently weaker exchange rate was fostering a desirable easing of the overall monetary conditions, and a larger interest rate cut was unlikely to weaken it significantly further. Oldřich Dědek noted the significant role of the CNB’s large international reserve holdings, which allowed it to dampen any fundamentally unjustified exchange rate swings by intervening in the foreign exchange market.
A majority of the board members felt that the risks to future inflation were tilted to the downside compared with the baseline scenario of the forecast. There was a consensus that despite the complex mix of demand and supply shocks, the anti-inflationary effect of subdued demand and overall economic activity would start to prevail strongly at the monetary policy horizon. The board members identified the outlook for wage growth, which in their view would be far more muted next year, as the biggest risk of potential non-materialisation of the inflation forecast at the monetary policy horizon. In this context, however, it was also said that the labour market cooling and related drop in wage growth might be partially offset by a renewed decline in the labour market participation rate in some cohorts (Jiří Rusnok, Tomáš Holub). In addition, Vojtěch Benda pointed to the risk of substantially lower imported inflation, as the ECB had long been trying unsuccessfully to lift euro area inflation to 2% even before the pandemic broke out. Also on the inflation downside, Tomáš Holub mentioned the risk of a stronger koruna, which might appreciate in the event of better epidemiological developments, in contrast to what the baseline forecast scenario expected. The Board conversely identified food prices as an upside risk to inflation. As a result of quarantine and weather factors, food prices would rise rapidly in the near term in an environment of limited supply and elevated production and transport costs, amid still solid consumer demand for food. In the longer term, the fact that part of the decline in economic activity would occur through a decrease in potential output, which would cause the negative output gap to widen more slowly, could have a more inflationary effect. The decline in the rate of growth, or even the level, of potential output would reflect deglobalisation, consisting in supply chain disruptions and international mobility constraints.
After debating the forecast for inflation at the monetary policy horizon, the board members discussed the optimal interest rate level. Vojtěch Benda said that all three scenarios implied quite a sharp monetary policy easing going beyond the standard interest rate cut of 25 basis points. It was said repeatedly in the discussion that the baseline scenario of the forecast was consistent with a 50 basis point reduction. However, a majority of the board members agreed they saw a need for a greater monetary policy easing given the risks captured in the two more pessimistic scenarios. Marek Mora expressed the view that a larger reduction in interest rates relative to the forecast could reduce the likelihood of a future need to use unconventional monetary policy instruments. It was also said that if things were moving in the clear direction implied by the present situation, there was a need to react sufficiently quickly and decisively without aspiring to do the usual fine-tuning of monetary policy (Jiří Rusnok, Tomáš Holub). A large interest rate cut would make it possible to support the economy and subsequently move away from the zero lower bound again more quickly. Jiří Rusnok and Oldřich Dědek noted the key role of fiscal policy in softening the economic impacts of the coronavirus crisis. Tomáš Nidetzký added that since the Board’s March interest rate cut, which, given the length of monetary policy transmission, had been of a signalling nature, the government had adopted a whole range of stabilising budgetary measures to minimise the immediate negative impacts of the pandemic on the economy.
In the discussion about the two more pessimistic scenarios, it was said that although they implied an even greater easing of monetary policy than the baseline scenario, both were signalling only a disinflationary environment, not a deflationary one (Vojtěch Benda, Oldřich Dědek). However, Tomáš Holub pointed out that the pandemic resurgence scenario was consistent with highly accommodative interest and exchange rate components of the monetary conditions, without which there would, on the contrary, be a very real risk of deflation. This scenario would therefore necessitate quite strong unconventional monetary policy measures if the zero lower bound was reached. As regards reaching the zero lower bound, which for most of the board members would be a signal for the potential use of unconventional monetary policy instruments, Jiří Rusnok and Tomáš Holub said that in subsequent deliberations it would be appropriate to focus on instruments the CNB could decide to deploy quickly on its own and could also implement in practice.
The board members also repeatedly expressed opinions on financial stability matters. Further to the debate about interest rates, Tomáš Nidetzký and Vojtěch Benda voiced concerns that very low rates might have an undesirable impact on the stability and profitability of the financial sector. Against this, it was said repeatedly that from the financial stability perspective, although a larger interest rate cut would take interest income away from the financial sector, it could on the other hand lessen the financial burden on indebted firms and households (Marek Mora, Oldřich Dědek, Tomáš Holub). In this context, the Board agreed that the Czech financial sector as a whole had sufficient liquidity and capital, reflecting its long-running profitability and the countercyclical buffers it has created. In all probability it would thus also be able to withstand a large stress. This was evidenced by its very good results in the regular stress tests, as Tomáš Holub and Aleš Michl noted. However, it was also said several times that a decline in profitability and liquidity in the financial sector could result in tighter financial conditions and more expensive loans. In this regard, the Board agreed it was desirable to react preventively to any decline in the financial sector’s liquidity by modifying the liquidity-providing programmes.
The board members also devoted part of their discussion to the transmission of monetary policy rates to loan rates. Vojtěch Benda and Tomáš Nidetzký mentioned the cyclical behaviour of risk premia, growth of which at times of crisis partially reduces the effect of cutting monetary policy rates. On this issue, Oldřich Dědek noted that according to the latest figures, client interest rates had decreased in response to the easing of monetary policy by the CNB, despite the said effect of rising risk premia. Oldřich Dědek and Aleš Michl stated that this was another reason to continue easing monetary policy, which would reduce the cost and boost the supply of money. On the other hand, Tomáš Nidetzký pointed to the risk that overleveraging could in the future create problems in the banking sector similar to those apparent in certain member countries of the euro area.
At the close of the meeting the Board decided by a majority vote to lower the two-week repo rate by 75 basis points to 0.25%. At the same time, it lowered the Lombard rate to 1.00%. The discount rate remained unchanged at 0.05%. Five members voted in favour of this decision: Jiří Rusnok, Marek Mora, Vojtěch Benda, Oldřich Dědek and Tomáš Holub. Two members voted for lowering the repo rate by 50 basis points: Tomáš Nidetzký and Aleš Michl.
Author of the minutes: Martin Motl, Monetary Department