Minutes of the Bank Board Meeting on 4 November 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 seventh situation report and the new macroeconomic forecast. Consistent with the forecast was a sharp rise in market interest rates at the end of this year and the start of 2022. This was in response to the current exceptionally strong inflation pressures in the domestic and foreign economies. Headline inflation would rise significantly further at the close of this year and approach 7% during the winter. Inflation would gradually fall in the course of next year, aided by monetary policy, and would decline close to the Czech National Bank’s 2% target over the monetary policy horizon. The forecasted sharp interest rate increase was also helping to anchor firms’ and households’ inflation expectations. The Bank Board assessed the uncertainties and risks to the new forecast as being significant but not calling into question the message of the forecast overall.

The board members discussed the factors underlying the current and forecasted inflation and agreed that the strong domestic price growth was undoubtedly due in part to global cost pressures. They were being generated by high commodity prices and also reflected problems in global production chains. Supply-side issues were causing industrial and consumer prices to rise and were also slowing economic activity. Nonetheless, the prevailing view was that domestic inflation pressures, which were of a demand-pull nature and primarily reflected an overheated labour market, were also playing a significant role in the sharp price growth seen in the Czech Republic. Monetary policy had to respond to these domestic inflation pressures. Conversely, Oldřich Dědek and Aleš Michl said that external cost factors were the dominant cause of the high inflation, and they were beyond the control of domestic monetary policy.

The Board discussed the anchoring of inflation expectations. Jiří Rusnok, Marek Mora, Vojtěch Benda and Tomáš Holub warned against a loss of anchoring of inflation expectations and said that monetary policy had to respond to that risk. Conversely, Oldřich Dědek and Aleš Michl said that the rise in inflation expectations was temporary and the cost shock situation needed to be better explained to the public for inflation expectations to stabilise. Oldřich Dědek added that he saw no signs of a wage-inflation spiral emerging at present and pointed to a number of differences compared with the oil crisis (decentralised wage bargaining and an absence of indexation mechanisms).

In the discussion, Jiří Rusnok and Tomáš Holub noted that the CNB’s primary mandate is to maintain price stability. Fulfilling that mandate in the present environment of elevated inflation expectations and an overheated labour market required a forceful increase in interest rates. Vojtěch Benda and Marek Mora emphasised that the situation of the Czech economy differed significantly from that of many other European countries mainly in that the Czech labour market was very tight. This was generating substantial demand-pull inflation pressures and increasing the likelihood of second-round cost-push inflation impacts. The inflation pressures therefore could not be relied on to dissipate spontaneously in the case of the Czech economy.

In the discussion, Oldřich Dědek and Aleš Michl emphasised the prevailing strong uncertainties. In their opinion, to fulfil the CNB’s price and financial stability mandate over the long term it was first necessary to establish stability in the economy. The current situation, marked by production problems in the key automotive industry, an energy crisis and a worsening pandemic situation, required monetary and fiscal policy coordination to support the hardest hit areas of the Czech economy. In their view, aggressive monetary policy tightening would prevent this by limiting the room for fiscal policy stabilisation and consolidation efforts, and would simultaneously only increase the risk of a second recession and expose the exchange rate of the Czech koruna to the risk of instability. Oldřich Dědek and Aleš Michl therefore concurred that they would not take part in interest rate races. In this regard, however, Jiří Rusnok stressed that fiscal dominance should not outweigh the CNB’s primary mandate to maintain price stability. Aleš Michl said that price stability could not be achieved in the long term without economic and public finance stability. Marek Mora said that excessively procyclical fiscal policy was also contributing to the high inflation.

Vojtěch Benda and Tomáš Holub mentioned the forecast risk consisting in the duration of the production and supply chain disruptions. Longer-lasting disruptions could give rise to additional price pressures in the global and domestic economies.

The Board also discussed the exchange rate of the koruna. Its evolution was repeatedly referred to as an inflationary risk to the forecast. The weaker-than-forecasted exchange rate so far in the fourth quarter of this year may reflect the negative sentiment arising from the problems in global production chains, which was amplifying the inflationary effect of this cost factor. According to Vojtěch Benda, moreover, the change in Fed monetary policy might mean that a higher interest rate differential than in the past would be needed for the koruna to strengthen.

The discussion also covered anti-inflationary risks to the forecast. According to Marek Mora and Tomáš Nidetzký, the potential transmission of supply chain problems to demand and the sentiment of economic agents was an anti-inflationary risk. This could lead to anti-inflationary cyclical pressures. However, Vojtěch Benda, felt that this risk was low. Marek Mora said that stronger fiscal consolidation and easier conditions for employing workers from third countries would pose an anti-inflationary risk to the forecast. However, a majority of the Board agreed that fiscal consolidation was more likely to occur later and hence that this risk did not affect the current monetary policy stance. An anti-inflationary risk pointed out by Marek Mora and Tomáš Nidetzký was the negative income effect of high energy prices on the consumption and disposable income of households.

A worse pandemic situation was mentioned several times as a risk going forward. Tomáš Holub said that the potential introduction of lockdowns in the event of a worse epidemic situation represented an upside risk to inflation, as past experience showed that such lockdowns were stagflationary, and hence inflationary, rather than anti-inflationary.

Tomáš Holub said that raising interest rates would also help the CNB fulfil its financial stability mandate, because growth in rates would slow house price growth and reduce the observed overheating of the mortgage market. Aleš Michl again recalled the proposal he had made in the spring of this year to slow the growth in the quantity of money in circulation by tightening the LTV ratio for mortgage loans in a situation of significantly overvalued property prices, a proposal which the Board had not approved. However, the other board members said that it had not been approved mainly because of unfinished legislative changes in this area at the time.

At the close of the meeting the Board decided to increase the two-week repo rate by 125 basis points to 2.75%. At the same time, it increased the discount rate to 1.75% and the Lombard rate to 3.75%. 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 Brůha, Monetary Department