Minutes of the Bank Board Meeting on 6 May 2021
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 rise towards the upper boundary of the tolerance band around the CNB’s 2% target in the next few quarters. Inflation would return close to the target next year, aided by a gradual tightening of the monetary conditions. Consistent with the forecast was stability of market interest rates initially, followed by a rise in rates from roughly the middle of this year onwards.
The Bank Board assessed the uncertainties and risks of the new forecast as being less substantial than in the previous forecasts and as broadly balanced overall. A more gradual fading of the pandemic, linked with lengthier lockdowns and a cyclical downturn at home and abroad, which could have anti-inflationary impacts, was a risk to the forecast. A risk in the opposite direction stemmed from the disruption to global production and supply chains and its pass-through to prices.
According to the Board, the perceived uncertainties and risks associated with the course of the pandemic had decreased, because the domestic epidemic situation had clearly improved. The anti-epidemic measures were now being eased, albeit only gradually so far. The ongoing vaccination process was repeatedly mentioned in this regard. Jiří Rusnok said that countries such as Israel, USA and the UK had demonstrated that vaccination against COVID-19 works. He then noted that despite the initial problems, the EU – including the Czech Republic – was now abundantly supplied with vaccines. A large percentage of the Czech population should thus have received at least one dose of the vaccine in the coming weeks, on top of those who had antibodies from the illness. However, Oldřich Dědek pointed out that the pandemic was progressing very unevenly on the global scale and that the current dramatic epidemic situation in some developing countries could disturb the fragile equilibrium again in the rest of the world. Marek Mora and Tomáš Holub also pointed to the risk of insufficient vaccination coverage in less developed countries and of new strains of the virus. In their opinion, this could lead to the reintroduction of various anti-epidemic restrictions and the need to start another round of vaccination using modified vaccines immediately after the current one ends. The Board nevertheless identified the longer-lasting pandemic scenario as less probable. However, Marek Mora and Tomáš Nidetzký recalled the situation in May 2020, when it had also been hard to imagine that the coronavirus pandemic would return in the autumn and winter, especially in such dramatic waves. On the other hand, Marek Mora said that the present situation was very different in that an effective vaccine was available and progress had been made in developing effective medication. As for the other external risks and uncertainties, he mentioned concerns about the soundness and robustness of the euro area financial sector. In his view, this could culminate in another debt crisis, while the previous crisis in the euro area had occurred in a situation where sovereign debt levels were much lower than they are today.
The next part of the Board’s debate focused on the domestic economic situation. Vojtěch Benda and Oldřich Dědek pointed out that the GDP forecast for this year was pessimistic relative to the market consensus. Tomáš Holub noted that the same went for the comparison of the growth forecasts for the Czech economy and the euro area. In previous business cycles, the domestic economy had usually grown faster than the euro area in the recovery phase. The board members also discussed the recently published preliminary GDP growth estimate for the first quarter of this year, which was indicating a much more moderate decline in economic activity by comparison with the forecast. Tomáš Nidetzký and Tomáš Holub pointed out that the contribution of the shadow economy had apparently increased, as the anti-epidemic restrictions had pushed economic activity partially into the unofficial zone. Economic activity might hence be in better shape in reality than indicated by the standard macroeconomic data. Oldřich Dědek said that even though he attached considerable weight to this figure, it was still a preliminary estimate and might be revised later on. Vojtěch Benda noted that besides the preliminary GDP estimate, the monthly economic indicators were indicating a faster recovery as well. Aleš Michl pointed out that the recently introduced Rushin index, which he was involved in designing and which analyses domestic economic activity in real time, was also indicating a subdued decline in GDP at the start of the year. According to Oldřich Dědek, past experience likewise suggested that the lifting of anti-epidemic measures had subsequently been reflected in a faster recovery than originally expected. Marek Mora added that the speed of recovery would also depend on how burned out firms and households were – for example, how flexibly people would react to the reopening of the economy in terms of moving forced savings back into consumption.
The Board also commented on the new fiscal outlook, which for this year had shifted towards greater expansion. However, Marek Mora and Tomáš Holub pointed out that public finances might undergo partial consolidation in the medium term in response to the recent generous fiscal policy. Marek Mora also identified the fiscal policy response to the lifting of the anti-epidemic restrictions as a short-term uncertainty, along with a potentially stronger fiscal impulse ahead of the autumn parliamentary elections. The board members repeatedly said that the current absence of a concrete fiscal consolidation plan represented a large uncertainty at the longer end of the forecast horizon. In this regard, Oldřich Dědek mentioned the potential negative effect on the exchange rate.
The Board also discussed the domestic inflation forecast, which saw inflation rising towards the upper boundary of the tolerance band in the next few quarters. Vojtěch Benda pointed out that this rise was stronger than estimated by financial market analysts. Jiří Rusnok, Tomáš Nidetzký and Tomáš Holub viewed the new forecast as a shift towards a stagflationary economic story in which a worse short-term outlook for real economic activity was accompanied by a more inflationary effect of the domestic economy. Marek Mora noted that the rise in prices attributed to the cost-push supply shock also reflected an acceleration of demand, which he did not regard as a stagflationary situation. Jiří Rusnok and Marek Mora also mentioned a significant change in the view of the composition of supply and demand factors, one which attributed a larger part of the GDP decline last year and this year to drops in potential output at the expense of a less negative output gap, which had inflationary implications. Repeated mention was also made of the pressures – taken on board by the forecast – arising from rising global prices of crude oil and non-energy and food commodities, which were feeding through to growth in industrial and agricultural producer prices (Tomáš Nidetzký, Oldřich Dědek, Tomáš Holub). Marek Mora and Vojtěch Benda identified the possibility of these foreign cost pressures lasting for longer as upside risk to inflation, whereas the forecast assumed that they would be short-lived. In addition, Oldřich Dědek pointed to the tendency of businesses to compensate for past losses caused by the government anti-epidemic measures by raising their prices, especially in services, which had been shut down for a long time. Against this, Vojtěch Benda and Tomáš Holub said that the hospitality segment, for example, was highly competitive, with high price elasticity of demand. In their view, the potential for this segment to increase its profit margins significantly in the long term was therefore low, even though consumers – following the long shutdowns – might in the short term view services such as hospitality as scarce goods and not pay too attention to their prices. Oldřich Dědek responded by saying that if, generally, a change or event affecting entire sectors is concentrated into a single moment in time, the competitive environment will not play a major role, because at that moment everyone will act similarly. Tomáš Holub also conceded that across-the-board lifting of anti-epidemic measures would involve coordination effects.
In the discussion about interest rates, a majority of the board members agreed that the monetary policy tightening decision had moved much closer since the last meeting. In this context, Marek Mora and Tomáš Holub pointed out that raising interest rates already at the late-June monetary policy meeting was de facto consistent with the forecast and with keeping inflation close to the target at the monetary policy horizon. Against this, Aleš Michl said that interest rates should remain unchanged until the epidemic had been brought under control. In reply, Marek Mora, Vojtěch Benda and Tomáš Holub said that this would not be known for sure for a long time yet, because the pandemic entailed a specific type of risk requiring a special approach. In their opinion, overcautious monetary policy might therefore even be harmful in this case. Marek Mora added that if the Board believed in “vaccination, reopening, recovery”, the time for voting to raise interest rates was already inexorably approaching. Given the shift of the inflation forecast for the year ahead towards the upper boundary of the tolerance band, Marek Mora and Tomáš Holub pointed out that even a relatively small surprise in the inflationary direction could take inflation above this band. Increasing interest rates too late could in their view thus entail costs as regards the anchoring of inflation expectations, an important part of the CNB’s primary mandate to maintain price stability. According to Tomáš Holub, stagflationary developments are generally unpleasant for monetary policy, because they give rise to the classic dilemma between achieving price stability (the primary objective) and supporting the real economy (the secondary objective). In this context, Jiří Rusnok and Tomáš Holub emphasised that the CNB is and will remain a central bank that focuses on fulfilling its primary statutory mandate of price stability. Jiří Rusnok praised the fact that the CNB was continuing to achieve its mandate using conventional monetary policy instruments alone. He personally regarded this as a great success, as there were no longer many such central banks in Europe. In this area, he was of the opinion that every use of unconventional monetary policy instruments entails costs.
The Board also debated financial stability. It discussed property market prices and the related surge in new mortgages. According to Tomáš Holub, this trend might largely reflect growing public concerns of a highly inflationary post-pandemic world. In his opinion, this was leading many people to invest in property in fear of the expected high inflation. Tomáš Nidetzký and Tomáš Holub also pointed out that the strong demand for new mortgages also reflected various marketing incentives used by sellers due to expected growth in interest rates, the likelihood of which was clearly increasing over time. According to Tomáš Holub, postponing interest rate increases for longer therefore entailed costs as regards the credit market situation as well. For this reason, financial stability was figuring more strongly in his monetary policy considerations than it had been for a long time. Tomáš Nidetzký added that mortgage interest rates were historically correlated very closely with yields on long-maturity financial market instruments, which had already started going up.
Following the monetary policy assessment of the overall situation, the Board agreed on the need to ensure that the configuration of the CNB’s monetary operations did not prevent a future increase in interest rates. For precautionary reasons, those operations had been modified and expanded immediately in response to the outbreak of the pandemic last year. In this respect, the Board identified the three-month facility for providing liquidity to credit institutions – offered with no mark-up on top of the two-week repo rate – as superfluous and as potentially counter-productive with regard to monetary policy implementation. There was a consensus that in the present situation it was enough to retain the option for credit institutions to use the two-week facility where necessary.
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%. The Board additionally decided to abolish the three-month repo operations for providing liquidity to credit institutions with immediate effect.
Author of the minutes: Martin Motl, Monetary Department