Minutes of the Bank Board Meeting on 30 September 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 sixth situation report assessing the fulfilment of the macroeconomic forecast contained in the fifth situation report in the light of the newly available information. In line with the current forecast, inflation was rising significantly above the upper boundary of the tolerance band around the CNB’s target in the second half of this year on the back of increased price pressures from the domestic and foreign economy. In August, however, it had been one percentage point higher than forecasted. Inflation would start to return towards the target next year, aided by this year’s tightening of monetary conditions. Consistent with the current forecast was a rise in market interest rates from the middle of this year onwards.

A majority of the board members assessed the risks and uncertainties of the summer forecast as being markedly inflationary and hence requiring a faster rise in interest rates compared with the current forecast. Jiří Rusnok said that economic performance and other macroeconomic indicators were returning to pre-pandemic levels. It was therefore rational to consider whether interest rates should also converge relatively quickly to their pre-pandemic levels, unless there was some fundamental factor preventing this, so that the central bank would deliver on its mandate to maintain price and financial stability. According to Tomáš Holub, there was a combination of foreign and domestic inflationary factors of both a demand and supply nature, so there was no reason to hesitate to tighten monetary policy. Real interest rates would remain significantly negative even so. Other board members agreed. It was more a case of making monetary policy less accommodative than tightening it.

A large part of the debate was devoted to external cost shocks, which accounted for much of the current high domestic inflation and would last longer than previously expected. The central bank’s job was to prevent the mostly temporary cost shocks from being reflected in sustained growth in inflation in an environment of high demand and elevated inflation expectations. Inflation was currently a subject of public debate and reference was being made to its high rate in wage bargaining and similar negotiations. It was said repeatedly that such expectations had to be stopped from forming in order for price stability to be maintained.

All this was going on amid a tight domestic labour market, which, according to Tomáš Nidetzký, also had the potential to be a strong inflationary factor at the monetary policy horizon, i.e. next year. Jiří Rusnok said that the labour market tightness had been accompanied by quite generous increases in wages in some parts of the public sector. A partially inflationary wage spiral had thus been in place for some time. Marek Mora noted that the second-round inflation effects of the external cost shocks might be stronger in the domestic environment than in other countries. Vojtěch Benda added that the “maximum safe speed” of the Czech economy was not as high now as it had been in the past decade. With the labour market overheated, the labour supply exhausted and unemployment exceptionally low, growth of around 4% or 5% with no manifest inflation pressures could thus not be relied on. Jiří Rusnok agreed.

In this situation, a majority of the board members regarded an interest rate increase of 75 basis points as the optimal response. This forceful increase was aimed to support the return of inflation towards the target over the monetary policy horizon as well as the anchoring of firms’ and households’ inflation expectations. The pace of further tightening would be conditional on future developments and on the message of the next forecast.

Oldřich Dědek countered the arguments presented above. From a comparison of inflation in the Czech Republic with that in neighbouring EU countries (including Austria and Germany) – a favourable comparison for the Czech Republic – he surmised that the tight labour market, easy monetary policy and negative real interest rates were not generating the prevailing inflationary pressures. In his opinion, the primary source of the current inflation shock was brutal external cost pressures, added to which were rapidly rising property prices and sharp growth in prices of building materials, both of which were showing up in the imputed rent item of the consumer basket. However, none of these factors could be influenced by monetary policy, or rather their effect could only be mitigated at high cost. For this reason, he was also sceptical about the ability to influence the coming round of wage bargaining with the present sharp interest rate hike. However, he saw the hike having negative side effects: the creation of further cost-push inflation pressure in the form of higher costs of corporate operational financing and government debt funding. The wider interest rate differential would also create greater room for exchange rate instability. In Oldřich Dědek’s opinion, the optimal response was primarily to communicate that the shocks were temporary, as the main central banks were doing. In addition, Aleš Michl said that the future path of the economy could not predicted as well as we were accustomed to, and that raising interest rates in the Czech Republic could not be relied on to resolve anything at present. To anchor inflation expectations, it was primarily necessary to explain that the temporarily elevated inflation was due to a cost shock which would disappear when trading relations between suppliers and their customers returned to normal after the shutdowns. Marek Mora agreed that in normal times monetary policy should disregard temporary factors, but only where it was certain that their second-round effects would be minimal. However, this was not the case at the moment. Tomáš Holub also said that in the current situation, inflation expectations could no longer be fully relied on to stay firmly anchored at the 2% target solely on the basis of central bank communication with no clear monetary policy signalling action.

Some of the members said that raising interest rates was also useful from the financial stability perspective. Vojtěch Benda argued that the central bank had lifted most of the macroprudential brakes on mortgage lending last year and so should not wash its hands of the property market situation, which was also directly linked to the consumer price index via imputed rent. There was a need to react to this situation, too, by increasing interest rates. Tomáš Holub, Tomáš Nidetzký and Jiří Rusnok agreed. In this regard, Aleš Michl recalled the proposal he had made in the spring of this year to tighten LTV in a situation of significantly overvalued property prices, a proposal which the Board had not approved.

The Board briefly discussed monetary and fiscal policy interaction. Vojtěch Benda said that expansionary fiscal policy was not justified at a time of expected GDP growth of over 4% next year. Tomáš Holub also stated that there was no fundamental fiscal consolidation on the horizon at present and that its potential introduction by the new government would most probably not affect the macroeconomic situation until 2023.

At the close of the meeting the Board decided to increase the two-week repo rate by 75 basis points to 1.50%. At the same time, it increased the Lombard rate by 75 basis points to 2.50% and the discount rate by 45 basis points to 0.50%. Five members voted in favour of this decision: Jiří Rusnok, Marek Mora, Tomáš Nidetzký, Vojtěch Benda and Tomáš Holub. Two members, Oldřich Dědek and Aleš Michl, voted for leaving interest rates unchanged.

Author of the minutes: Jan Syrovátka, Monetary Department