Transcript of the questions and answers from the press conference
Could you please give us some details on the change in the considerations of the Bank Board, which took steps of 25 basis points at previous meetings. Now you’ve taken a significantly larger step than the market expected. Could you please explain the urgency, or why you did so? And perhaps a little more specifically, what would have happened if you hadn’t done so, if you’d raised rates by just 25 or 50 basis points as the market was expecting. We understand that you are concerned about increased inflation expectations, but could you please say a bit more specifically what such increased inflation expectations could cause in the economy.
Perhaps you will recall when we met here after our previous monetary policy meeting. I said then that there had been a long and serious discussion about the possibility of a hike of 0.50 percentage point at the last meeting in August. That was how it was then. We had that proposal before us at that time, but in the end the majority of the Bank Board preferred a smaller step. It was in fact the second time we’d adjusted the proposal made by the analysts of our relevant department downwards.
As to why that was the case, the Bank Board of course considers various aspects of its decision. The fact is that the situation predicted by the model and the current forecast at the previous monetary policy meeting did not look that urgent yet in the overall context. We were still largely hoping that the price growth, which had been strongly driven – to a larger extent previously than now – by external cost shocks, was more or less temporary. That is, after all, the mainstream story for other central banks around the world. We did share a part of that story – I’m not saying all of it, because in that case we wouldn’t have raised rates at all, but we had raised them twice already as you know.
However, the time from August up to now has confirmed that temporary may also mean quite long-lasting. Nobody knows exactly how long this is going to last – I mean the temporary nature of the inflation pressures from the global cost shocks. What we know with much more certainty today is that this is already strongly affecting the second-round and other components of inflation expectations and decisions and behaviour at all further stages of the economic chain. This means our inflation is no longer being driven by external effects alone, but also by domestic conditions, i.e. by how domestic economic agents – firms, households and the state – are responding to these developments.
Adding our specific situation to this, our labour market has been very tight for a long time – it was very tight before Covid, and Covid actually didn’t change it very much. We are returning to that very quickly, perhaps with a greater intensity in some cases. Unlike Western Europe and the USA, we had slightly higher inflation – above our target and at times even at the boundary of our tolerance band – already before Covid, roughly from 2019. This is a big difference between our country and the euro area, for example. So, we feel – and can already see from the new data – that inflation expectations, as measured by various surveys, studies and questionnaires, are becoming somewhat unanchored from our long-term target level of 2%. We have concluded that we cannot but react to that, in a decisive way, perhaps partly making up for what we “let happen” at previous meetings by not being as hawkish as we perhaps should have been and as the underlying documents suggested at the time.
The situation has changed. We all feel that the economy, in terms of the risks to its development, is now more or less largely free of the threat of any fundamental pandemic restrictions. We are aware that some risks still exist, but it is very unlikely that we will return – even during the new autumn-winter-spring season – to any large-scale lockdowns. This is prevented by vaccination coverage as well as, say, by legal custom, so it probably won’t happen. The economy has largely learned to live with the restrictions that remain in place. The economy is quickly returning to its original performance. We are experiencing a very specific shock caused by the pandemic: a sharp decline and a sharp return to the original level. The euro area, at least according to estimates and to the statements made by its representatives, will reach the pre-pandemic level at the end of this year. We will get there some time at the end of this year or the start of next year.
So, it is normal that we should also return our interest rates somewhere close to the normal level, say, the pre-pandemic level. For the record, that was 2.25%. Even after today’s forceful hike, we are at 1.5%, still below the pre-pandemic level and definitely well below the level of at least neutral real interest rates.
We feel that inflation expectations are becoming unanchored and we definitely don’t want to allow that. We are very well aware that inflation is still being driven strongly by external cost effects. But on top of those effects there are also domestic factors. And we certainly want to affect the second-round and other components of the price pass-through, which are now within the reach of domestic monetary policy. There is no doubt about that. Each individual decision of each household, each entrepreneur or firm, and ultimately also the state, is influenced by the level of domestic interest rates. We can, and must, influence that. It is part of our primary mandate to maintain price stability.
Therefore, a majority of the Bank Board concluded that we needed to make this decision today.
To follow up on that, as it hasn’t entirely been said yet, what were the arguments for a hike of 75 rather than 50 basis points? Because 50 points is also a forceful step, one which had been signalled by some Bank Board members, who said before the meeting that a forceful step may be needed. So why did you take an even more forceful step?
I probably won’t be able to cover all the arguments, but basically they pointed out that we need to return our rates to, say, a neutral level. We are still in expansionary monetary policy mode. We have deeply negative interest rates. In our opinion, the economy no longer needs monetary stimulation; it would be superfluous and contribute to an overheating of the economy. Signals of such overheating are present. I have already mentioned the labour market, and I will add the property market to that. Both these areas saw perhaps the overheating recede slightly during Covid, but it has returned quickly and is now back.
So, the direction of interest rate changes is clear. The debate now is basically only about the calibration of the pace of dosing. Given the urgency with which the cost pressures – but also the domestic inflation pressures, which are clearly visible, as we can see that prices of items almost solely produced in the domestic environment are going up: services, restaurants, some services like personal hygiene and hairdressing, travel in the form of package holidays, and so on – are coming at us, it is clear that the potential for domestic inflation pressures is sizeable. In the end, a majority of the Bank Board concluded that a forceful step of more than the expected 0.50 percentage point was warranted.
Just as a reminder, when the pandemic shock struck and nobody knew how the situation would unfold, we even cut rates by 0.75 percentage point at an extraordinary meeting. And now we are gradually going in the opposite direction, much more slowly in fact. At that time, we cut rates by 200 basis points in three steps. Now we have raised them by 125 basis points in three steps. So it undoubtedly looks forceful and certainly is so by international comparison, but we must still look at it in this context.
We simply need to get across a strong signal to society and the economy that we will not put up with inflation expectations very distant from our target becoming entrenched here. We are very well aware of how dangerous that is and how costly future efforts to return inflation expectations to our target would be. The longer we wait, the higher the future macroeconomic and social cost will be. It is a bit like in medicine. If you intervene too late, it takes much more sweat, blood, pain and effort, and if we are convinced about that, we can’t afford it.
How quickly do you expect today’s decision to be reflected in inflation?
Of course, nothing has changed about the fact that the monetary policy horizon is still 12–18 months. So, we expect the first effects of the tightening, or the return to normal monetary policy settings, to be visible in about a year. So, we expect that roughly a year from now, a slowdown in inflation should already be clearly visible.
It’s clear that in the next few months, and I quoted that in the statement, we will unfortunately continue to see an increase in the monthly inflation figures at the levels we have already reached, i.e. between 4% and 5%. A swing in either direction cannot be ruled out, as the monthly data are sometimes volatile. But it’s clear that inflation will remain highly elevated until the end of the year and probably also in the first quarter or half of next year. But sometime at the end of 2022 H1, and especially in Q3, the effects of our monetary policy should already be visible.
How much is your decision affected by the current government’s fiscal policy and the government’s fiscal policy outlook for next year? If fiscal policy was less expansionary, could your rate hike have been smaller? Can it be linked directly like that?
Generally speaking, you can probably link it like that, to be honest. We see analytical assessments that we are in a situation of strong fiscal expansion – and we have no credible outlook showing that a consolidation is to take place soon – in the sense that fiscal policy is generating relatively high deficits at a time of already very visible and strong economic growth, in fact growth running at the potential of this economy or maybe even beyond it.
It’s clear that this is contributing to an inflationary environment and hence it may also be indirectly affecting our decision-making in the direction of an outlook for tighter monetary conditions. This is clear, entirely logical and natural. It’s hard to add anything to that.
Of course, we are aware that fiscal policy doesn’t have a very long outlook at the moment. It is of course strongly determined by the political situation. However, the outlook that is crucial for us – one or two years – can be deduced from that quite well.
As for potential, it’s a theoretical category that tells us the optimal growth rate of the economy at which macroeconomic imbalances – in the area of inflation, unemployment, the external balance and so on – do not yet arise. Unfortunately, the potential of the Czech economy is not too high, according to our analyses and the observed data. To use a technical comparison, the “maximum safe speed” of the Czech economy is, according to my estimate, between 2.5% and 3%. It is clear, if I abstract from this year, which is exceptional due to a low comparison base, we may be slightly above the potential of the economy already next year. And that naturally supports the creation of imbalances, one of which may be inflation. That is not to deny that a large part of this inflation has come from abroad. But it is then also being supported by the domestic environment, in our case additionally the labour market, the property market and so on.
So, if fiscal policy continues to expect high deficits in this situation, in the order of 5% to 7% of GDP, it of course remains quite expansionary in this sense. Just to make clear methodologically what I mean by expansionary.
I want to ask about the debate several Bank Board members have mentioned in the past month, regarding a possible return to sales of the returns on the CNB’s international reserves. I want to ask how advanced the debate is – is it at the very beginning, or is a consensus already emerging? And, in your opinion, how likely is it that the programme, which was interrupted in 2012 or earlier, will be renewed? And your estimate of the timing – can we expect a decision this year, or is it a debate that will take more time?
I think we are at the very start of the debate. We are expecting a background document on this from our specialised departments sometime in October. They are expected to give us the main context and parameters of possible future considerations on how returns on international reserves should be treated. Our primary line of thinking is that, of course, we have international reserves that generate returns, and if we were to accumulate them permanently, the reserves would grow further and might grow relatively fast at certain times and the central bank’s balance sheet would expand further, which we actually do not need. It makes sense to discuss whether the returns should be gradually released onto the market and whether we should start naturally and slowly regulating the size of the balance sheet by doing that.
It’s a long-term thing, nothing acute. We certainly are not thinking about it as an auxiliary instrument of current monetary policy. In fact, we don’t even need it now from this point of view. We have sufficient room to increase interest rates, and that also has an indirect effect on the exchange rate. On the other hand, it is not a taboo that we can’t or shouldn’t discuss.
So, that’s where we are. We will talk about it in the final quarter of the year. I am now really unable to tell you whether the result will be a monetary policy decision and what it will be. But I certainly wouldn’t expect any factual results that will have an impact on monetary policy-making by the end of this year.
My question is about the calibration of the potential further tightening of monetary policy. The current forecast we discussed here last time implies hikes at each subsequent meeting this year and further increases next year, especially in the first half of next year. It also assumes a pause after rates reach approximately 2%. I’d like to ask how far the CNB wants to go in this cycle of monetary policy tightening – if it’s possible to talk about a cycle – and how the Bank Board is adhering to, or conversely turning away from, the August forecast.
First of all, I will again offer my interpretation of the context. Yes, relatively speaking, it is a tightening, but it is in fact a return to normal from a still highly expansionary mode. So again, we are not yet stepping on the brakes. We have merely taken the foot off the accelerator, and maybe we have started to engine brake a little, because we’re now going downhill a bit.
Naturally, I can’t tell you how far we want to go. Again, the standard level of our rates from the perspective of our model parameters – if we assume that we should be somewhere near a real interest rate of 1% – would probably be around 3%. However, that is the ideal, optimal level in the model. It is currently premature to speculate whether or not we will reach it. We’ll see how the domestic and global economy evolves further.
Second, we will have a new forecast at the next monetary policy meeting in six weeks’ time. It will probably differ considerably from the August one, as things are changing dynamically. We will make further decisions on the basis of the new forecast and an assessment of the overall situation. The direction is more or less clear: we will continue to increase rates. But I really can’t tell you now how quickly and how often, because it would be just shooting from the hip. We’ll see.
Some reactions to today’s decision have already appeared. The Minister of Finance says that this is no time to apply textbook rules and dislikes the rate increase. You can leave it without comment, of course, but still, if you could respond in some way… And an interesting comment was made by economist Jan Švejnar, who said that, due to your interest rate increase, “businesses will have a higher borrowing costs and will reflect that in higher prices of goods and services”. What do you think of that, and how would you refute it?
Forgive me, but I won’t comment on what the Minister said.
As regards Professor Švejnar’s view, we discussed this hypothesis as well. It was also voiced at today’s meeting. There is some logic to it, but the logic is incomplete. So far, the long-term global experience of economies similar to ours – medium-sized, medium-developed open economies with independent monetary policy and inflation targeting – doesn’t bear it out.
It’s relatively simple, because the real situation is such that the overwhelming majority of businesses cannot just increase their prices as they like or as one of their cost items increases, be it an increase in wages or an increase in the interest rate component of borrowing costs. To say nothing of the fact that Czech firms – this is a bit of a paradox, but this crisis is generally peculiar – have more own funds on average after the crisis than they had before it, so their dependence on operating loans is in fact lower. If you ask Czech firms whether a certain increase in interest rate costs is a major problem for them, then, if they are speaking frankly, they will tell you it’s a problem of minor importance. Their main problems are shortages of labour, material and components, and possibly uncertainty as to what taxes they will be paying. And the situation of their clients is crucial for them, of course.
Monetary policy has its costs. It is not neutral in terms of costs and redistribution. It cannot be. If it were, it couldn’t work and we wouldn’t need it. It will always entail some costs. Its purpose is to create an environment of long-term price stability, which is a necessary condition for the country, citizens, households, firms and the state to be able to prosper in the long term. Because if we lose price stability, its anchoring, it will be very hard to function efficiently in such a country in terms of investment, savings, exchange rate stability and so on. So, we follow the general public interest. That entails some costs, and we all pay them. That’s entirely normal.