Minutes of the Bank Board Meeting on 23 June 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 fourth situation report assessing the fulfilment of the macroeconomic forecast contained in the third situation report in the light of the newly available information. According to the current forecast, inflation would fluctuate around the upper boundary of the tolerance band in the quarters ahead and would return close to the CNB’s 2% inflation target from above at the monetary policy horizon. Consistent with the forecast was a rise in market interest rates from roughly the middle of this year onwards.
The Board started its discussion by agreeing that the spring forecast was materialising generally well. A majority of the board members assessed the risks and uncertainties of the forecast as being slightly inflationary overall, based on the updated outlook for the external environment and on new information about the domestic economy. Only the exchange rate of the koruna, which had been somewhat stronger than forecasted during the second quarter of this year, had been acting in the opposite direction. It was said repeatedly that the availability of a vaccine and the significant progress made in the treatment of COVID-19 represented a qualitative change in the coronavirus pandemic situation. Thanks to the better-than-assumed course of the pandemic, it had thus been possible to relax the domestic anti-epidemic measures earlier. That, in turn, was contributing to a faster recovery of the domestic economy, which had contracted less significantly in the first quarter than the spring forecast had predicted. A majority of the board members also agreed that a renewed deterioration of the epidemic situation during the autumn could not be ruled out. Given the swift progress of vaccination, however, this should not lead to across-the-board restrictions being reintroduced in the economy.
The Board split into three groups of opinion during the monetary policy meeting. The majority view, taken by Governor Jiří Rusnok along with Marek Mora, Tomáš Nidetzký and Tomáš Holub, was in favour of increasing the repo rate by the standard 25 basis points. All the aforementioned regarded this increase as a first step towards gradually normalising monetary policy rates, one that would primarily play a signalling role and anchor inflation expectations. According to some indicators, inflation expectations had started to creep up. For a central bank with a price stability mandate, this is a warning signal to which it has to react. The said group of board members regarded the standard interest rate increase of one quarter of a percentage point as sufficient to begin with, even though the slightly inflationary balance of risks to the spring forecast would argue for a larger increase. This was mainly in order to avoid exposing the markets to a surprise, which could give the false impression that the central bank had felt an urgent need to fight a fire in the form of dramatically high inflation.
According to Tomáš Holub, the priority now was to see to it that the current cost pressures did not spill over to an increase in inflation expectations. He would regard a delayed monetary policy response as a mistake. Central bank prevarication (otálení) should therefore not be added to the three Czech “Os” of vaccination (očkování), restart (otevírání) and recovery (oživení). In his view, the pandemic had ceased to be an asymmetric downside risk to domestic economic activity in the next few months, though he did detect a risk of virus mutations and related new partial measures for the autumn and winter.
Tomáš Nidetzký regarded developments on the labour market, which had cooled much less than originally expected, as one of the inflationary factors. In his opinion, the future path of inflation also depended on the course of the domestic business cycle. Only the coming months without stringent anti-Covid measures would tell us whether the economy was returning to a growth phase or would keep contracting gradually. For Tomáš Nidetzký, this uncertainty about the position of the economy in the cycle also implied uncertainty about the path of inflation over the monetary policy horizon and hence about the current monetary policy decision. In his view, however, both observed inflation and the inflation outlook were giving rise to a need to signal that the CNB would not tolerate a long-term deviation of inflation from the target.
For Marek Mora, the main uncertainty at the moment was how robust the link between the restart and the recovery would be. It seemed from the observations so far that the economy was recovering quite strongly in response to the restart. However, there were several question marks. The first concerned the speed of release of households’ forced savings – created through deferred consumption during the period of restrictions – and also their precautionary savings. According to Marek Mora, savings would spill over to consumption only partially. In particular, the part of disposable income arising from the reduction of labour taxation would not be spent, or would not be spent very quickly. His second question was how the sentiment of firms and households would be reflected in future economic developments. Nor was it clear what would happen when the government’s unprecedented interventions in support of the economy ended. In this regard, the coronavirus crisis was very different from the usual cyclical crises, and the central bank did not currently know how inflationary the recovery would be. On the other hand, the more than one year long experience with the COVID-19 pandemic had shown that the CNB’s interest rate cut to 0.25% last year had perhaps been an overreaction. He noted that at the time the Board had been responding to a completely unknown shock.
Jiří Rusnok said that risks and uncertainties remained, but their balance had shifted much more clearly in the inflationary direction. He believed that the supply-side disruptions would gradually abate and transport flows and the structure of the economy would both normalise. New producers of currently scarce goods would be found. This would cause the supply-side inflation pressures to diminish. However, on the other hand, according to Jiří Rusnok, demand-pull inflation would increase as the economy recovered rapidly. This was the part of inflation that the central bank must respond to. He referred to the specific nature of the Czech labour market as a breeding ground for growth in inflation expectations. According to Jiří Rusnok, these facts would not change before the next forecast, so he saw no reason to wait before starting to increase monetary policy rates.
Vojtěch Benda favoured increasing the repo rate by 50 basis points. He broadly agreed with the arguments set out above, but with the difference that he saw the current balance of risks as more inflationary. The process of easing was faster than we could have imagined a few weeks ago, and he did not expect a return to hard lockdowns. He could see positive developments both at home and abroad. Domestic GDP had declined far less than expected in the first quarter, while wages had grown faster. The foreign PMI was back in the expansion band, and a survey of foreign firms indicated that they were planning to recruit. He assessed this as a risk of continued higher-than-forecasted foreign producer price inflation. Vojtěch Benda did not see the observed exchange rate appreciation as sufficient to offset this effect on domestic import prices. Like Marek Mora, he noted that at the start of the pandemic the Board had for good reasons eased monetary conditions more than had been necessary to achieve the inflation target. For these reasons, Vojtěch Benda saw room for a bigger repo rate increase than 25 basis points. He personally did not regard a 50 basis point change to the repo rate as a panic signal by the central bank, although he understood it would come as a surprise to the markets.
Aleš Michl and Oldřich Dědek, by contrast, favoured leaving interest rates at the current level. Aleš Michl said that the repo rate should not change until COVID-19 had been brought under control. Oldřich Dědek pointed to some highly disturbing reports of a resurgence of the pandemic in other countries, which could force them to continue their fiscal and monetary policy stimulation measures. He emphasised the risks of premature normalisation (appreciation pressures and higher government borrowing costs) in a situation where the monetary policy of the major central banks remained in highly accommodative mode. He therefore felt that the CNB could wait at least until the next forecast before beginning to raise rates, a view supported by the latest inflation figures (a return into the tolerance band and a decline in core inflation). Jiří Rusnok noted that Czech government bond yields are affected only indirectly by the CNB and have long been set at the level determined by the market based on the credibility of the government debt.
At the close of the meeting the Board decided to increase the two-week repo rate by 25 basis points to 0.50%. At the same time, it increased the Lombard rate by 25 basis points to 1.25% and kept the discount rate unchanged at 0.05%. Jiří Rusnok, Marek Mora, Tomáš Nidetzký and Tomáš Holub voted in favour of this decision. Vojtěch Benda voted for increasing the two-week repo rate by 50 basis points. Oldřich Dědek and Aleš Michl voted for leaving rates unchanged.
A majority of the board members agreed that with the present decision, monetary policy is probably entering a phase of gradual growth in interest rates, which have been very low up to now. Interest rates can therefore be expected to continue rising in the second half of this year.
Author of the minutes: Kamila Kulhavá, Monetary Department