Minutes of the Bank Board Meeting on 5 November 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 seventh situation report and the new macroeconomic forecast. According to the forecast, headline inflation would decrease into the tolerance band and be close to the CNB’s 2% target over the monetary policy horizon. Consistent with the forecast was stability of market interest rates initially, followed by a gradual rise in rates in 2021. The current economic situation and economic outlook were being fundamentally affected by the ongoing coronavirus pandemic and the anti-epidemic measures gradually being adopted in the Czech Republic and abroad. The new forecast, including the said interest rate path, was therefore strongly conditional on the fulfilment of the assumptions made about the course of the epidemic situation and the anti-pandemic measures.

The Bank Board assessed the risks and uncertainties of the baseline scenario of the new forecast as being substantial. There was a consensus that the biggest anti-inflationary risk was a further possible worsening of the course of the second wave of the pandemic in the Czech Republic and especially abroad, going beyond the baseline scenario. In light of these significant uncertainties, the Bank Board considered it likely that interest rates would be left at a low level for longer than assumed in the baseline scenario of the forecast.

A majority of the board members viewed the external assumptions of the forecast as optimistic. A worse course of the second wave of the pandemic around the world posed a considerable risk to the forecast. The Board therefore welcomed the worse pandemic scenario that had been prepared. A majority of the board members regarded a more strongly anti-inflationary trend abroad as quite likely. According to Tomáš Holub, the forecast optimistically assumed a rapid renewal of growth in the fundamental component of producer prices in the effective euro area to 2% next year despite a negative output gap. Marek Mora and Tomáš Nidetzký noted the risk of a no-deal Brexit, the change in the internal political situation in the USA, and the impacts on its trade relations with China and the EU in particular. Against this, Oldřich Dědek said Joe Biden’s election as US president could, on the contrary, lead to a reduction in external risks, for example in the form of an exit from the power politics of using tariffs to promote US trade interests. Marek Mora nonetheless noted that regardless of the winner of the US presidential elections, he expected some tensions to persist in US–China trade relations.

The board members went on to compare the first wave of the pandemic in the spring with the current second wave. There was a consensus that there could be big differences between their economic impacts. In this regard, Marek Mora noted that households and firms were entering the second wave in a state of much greater financial exhaustion and that the levels of exhaustion could be getting critical in some cases. This would lead to inevitable structural changes in the economy, some of which would be permanent. The board members also agreed that the autumn shutdown of the economy would be smaller in scale but longer-lasting compared with the first wave. Overall, this would lead to a larger decline in demand than supply, and hence to lower inflation. It was said repeatedly that on top of the anti-epidemic measures announced by the government, there would be some spontaneous social and economic distancing and a deterioration in household and business sentiment (Jiří Rusnok, Marek Mora, Tomáš Nidetzký). In this context, Marek Mora and Vojtěch Benda said that the more frequent and longer were any future waves of the pandemic, the more this spontaneous effect would weaken as people got used to the situation. Jiří Rusnok pointed out that even a vaccine would not necessarily cause the disease to disappear completely. By way of an example, he mentioned the usual seasonal flu epidemic, which occurred every year despite a vaccine being available. In this regard, opinions were expressed (Jiří Rusnok, Vojtěch Benda, Aleš Michl) that society would have to adapt to, and learn to live with, the novel coronavirus and function economically. Aleš Michl mentioned Asia as a good example of this approach.

The Board also discussed real economic activity. It stated that the upward revision of the full-year GDP forecast for this year reflected a rather milder economic decline in the second quarter followed by a stronger recovery in the third quarter after the spring restrictions had been relaxed. According to Marek Mora, this reflected the fact that Czech firms and households had entered the first wave of the coronavirus pandemic in very good condition. The economy had therefore reacted better than expected. Its overall performance this year would thus be rather better despite the second wave of epidemiological measures, which the previous forecast had not counted on. In this regard, Tomáš Holub pointed out that the forecast logically did not assume an equally deep decline of the economy in the current quarter as the one that had occurred in spring. This was due to the so far considerably smaller downturn in industry, which was now no longer likely to be shut down. Jiří Rusnok noted that the new forecast additionally predicted slower GDP growth next year compared with the previous outlook. In his view, this was reasonable given the current situation.

The board members agreed that fiscal policy was playing the key role in mitigating the impacts of the pandemic. In this regard, Aleš Michl pointed to the distinctly negative fiscal impulse expected by the forecast next year, which he would regard as a mistake. There was a consensus that fiscal policy would be more expansionary than assumed in the baseline scenario. In this context, the Board welcomed the fact that a fiscal scenario assuming the adoption of additional budgetary measures had been prepared. Marek Mora noted that, on the one hand, governments would be under strong political pressure to provide further fiscal stimulus, but, on the other, there would be persisting uncertainty about the scale and duration of this fiscal support given the possibility of further waves of the coronavirus. Besides prompting discussions about public finance sustainability, this would raise questions about which economic sectors it made sense to support as regards their viability, and how to go about providing such support. Aleš Michl also said that, in parallel with announcing support measures, the government should prepare a fiscal consolidation plan leading gradually – from 2022 onwards – to a balanced budget if the economy returned to growth.

As for the exchange rate, there was a consensus that it was currently fostering a desirable easing of the monetary conditions. Oldřich Dědek said the exchange rate had recently been determined solely by swings in external sentiment. In early autumn, it had reacted to the rapidly worsening epidemic situation by depreciating sharply. By contrast, he linked its present appreciation with, among other things, the course of the presidential elections in the USA and the decrease in risk aversion on global financial markets. This indicated that the exchange rate was currently moving entirely autonomously, irrespective of the domestic interest rate settings. Tomáš Nidetzký noted that currently, unlike during the spring wave of the pandemic, the weakening of the koruna was having a stabilising effect on the export-oriented Czech economy, thanks to functioning global supply chains. Aleš Michl saw exports as a possible way out of the current recession. He noted that a symmetrical shutdown of economies had occurred on the global scale in the second quarter of the year, and that this had led to a sharp downswing in foreign trade. By contrast, the second wave of the coronavirus crisis was proceeding in different ways in different countries, while international trade had quickly recovered in the meantime. The Czech economy should benefit from this if domestic exporters could be kept running.

Some of the board members also repeatedly commented on the observed path of inflation, which had recently been hovering above the upper boundary of the tolerance band around the target. According to Jiří Rusnok and Oldřich Dědek, this – taking core inflation also into account – testified to the strong inertia of the domestic fundamental inflation pressures. The first wave of the pandemic had not had any major disinflationary impact either. Marek Mora linked this with the strong labour market and related wage growth. As one possible factor in the Czech Republic, he and Vojtěch Benda mentioned the still relatively low rate of replacement of labour by capital, which has long been reflected in sluggish growth in private investment. On the other hand, Tomáš Nidetzký noted that inflation pressures were no longer rising substantially and could be expected to fade away soon as the labour market continued to cool. The CNB’s flexible inflation targeting regime the meanwhile meant that temporary deviations from the target on either side could be tolerated, with no loss of reputation and without inflation expectations becoming unanchored. Vojtěch Benda noted the elevated inflation seen in non-euro area countries of the Central European region. This could reflect the joint depreciation of their currencies during the pandemic and highly negative real interest rates well below the euro area level.

The Board agreed that despite parallel stagflationary supply-side effects, anti-inflationary demand-side impacts would prevail overall at the forecast horizon. Marek Mora said that in most advanced countries, anti-inflationary negative demand factors were dominant, while the stagflation tendencies were not very strong. Tomáš Holub noted that the anti-inflationary impacts of the first wave had not yet been fully felt in the economy. On the other hand, the second wave might also have short-term stagflationary effects, albeit less so than the first wave. A majority of the board members agreed that the anti-inflationary pressures associated with the classical cyclical impacts of the recession and the labour market downturn would be longer lasting and stronger than the forecast predicted. Given the high inertia of the anti-inflationary demand pressures, the Board therefore viewed the forecasted start of monetary policy normalisation in the second quarter of next year as over-optimistic. According to Vojtěch Benda, post-pandemic economic developments would also be an important factor, i.e. whether the structure of the economy would change, and whether stronger or, conversely, weaker inflation pressures would be generated, amid similar labour market trends as in the past.

In the discussion of the monetary policy settings, there was a consensus that the monetary conditions could currently be assessed as sufficiently accommodative, so there were no immediate grounds for changing interest rates. However, the Board simultaneously saw uncertainties and risks at the longer end of the forecast. In a debate about the future monetary policy settings, a majority of the board members assessed the risks as being tilted towards longer-lasting interest rate stability compared with the forecast. Against this, Vojtěch Benda said he regarded the increase in interest rates starting in the second quarter of next year as very gradual and consistent with the recovery expected to occur after the second wave of the pandemic subsided. However, Tomáš Holub pointed out that the external outlook was – rather unintuitively – fostering higher interest rates in the forecast via latent depreciation pressure on the koruna. Given the experience of 2014–2016, however, external developments might, on the contrary, generate anti-inflationary pressures in the domestic economy, to which it would be necessary to react with lower interest rates. As a factor favouring interest rate stability, conversely, Oldřich Dědek mentioned the risk of easier monetary conditions via the exchange rate. On the one hand, Jiří Rusnok said the forecast opened up room to consider starting to normalise interest rates gradually next year, which would involve the central bank targeting the situation in 2022–2023. On the other hand, though, he added that these projections were subject to considerable uncertainty. Oldřich Dědek stated that the uncertainties of the forecast were compounded by the fact that the forecast was trying to pinpoint the start of the monetary policy normalisation process.

The Board went on to discuss the two additional forecast scenarios mentioned above. The worse pandemic scenario pointed to a need to lower interest rates hypothetically below zero and thus consider using unconventional monetary policy instruments. The more expansionary fiscal policy scenario conversely suggested higher interest rates than in the baseline scenario of the forecast. Jiří Rusnok stated that both sensitivity scenarios of the forecast were highly likely to materialise simultaneously to some extent, but it was virtually impossible to estimate the extent of their opposing effects. Following this discussion, a majority of the board members considered it more likely that interest rates would be left at a low level for longer than assumed in the baseline scenario of the forecast.

Part of the Board’s debate was devoted to the financial stability area. In this regard, Tomáš Nidetzký noted that the domestic financial system remained highly resilient, in contrast to some other European countries. Monetary policy could thus be focused fully on achieving its primary objective of price stability. Aleš Michl said he regarded the money supply as sufficient. He mentioned that modified CNB liquidity-providing operations had been prepared for banks and non-banks for the eventuality of liquidity shortages, but they had not been used in practice so far. On the other hand, according to Aleš Michl, demand for money had slowed as a result of a decline in corporate investment activity and banks’ cautious approach to lending. However, the situation was in no way dramatic at present. In this context, Marek Mora noted that if the second wave of the coronavirus crisis were to be prolonged, the firms affected would run into liquidity problems. This would negatively affect their solvency and could even cause them to collapse. From the perspective of the potential scope of the crisis, Jiří Rusnok pointed to the spillover of negative effects into sectors that had not been impacted directly by government restrictions but had business links to firms directly affected. Oldřich Dědek and Aleš Michl pointed to the risk of the mortgage market overheating further, as new mortgages were hitting record highs amid continued growth in house prices, despite the coronavirus crisis.

At the close of the meeting the Board decided unanimously to leave interest rates unchanged. The two-week repo rate remains at 0.25%, the discount rate at 0.05% and the Lombard rate at 1%.

Author of the minutes: Martin Motl, Monetary Department