Transcript of the questions and answers from the press conference

Five Bank Board members were in favour of the announced increase and two were for leaving rates unchanged. The markets and analysts expected 0.75 or 1 percentage point. What was the biggest cause of disagreement?

The cause of disagreement remains the same. A minority of the Bank Board believe that the inflation is due mainly to cost pressures and that monetary policy doesn’t have effective tools to prevent them. Moreover, those colleagues prefer to boost the recovery, or rather are afraid that it might be jeopardised, and therefore believe that there’s no reason to raise interest rates so forcefully for now. I’d say their rhetoric is quite similar to what we hearing from some Western European or world central banks about the temporary nature of the surge in inflation, but I think they will explain it better themselves.

As regards the majority, they clearly agree with the forecast and the analytical documents prepared by our experts, i.e. that at least 40%, or maybe more likely 50%, of the inflation pressures in our situation are due to domestic factors. So, they are not being generated primarily by foreign prices. They are derived factors.

Of course, our economic story, unlike, for example, that of the euro area, is different in that we were experiencing some inflationary tensions even before Covid. At that time, we had a relatively extensive debate on whether we should possibly have tightened a bit faster back then, when rates were around 2.25%. We increased rates in February just before Covid. We long had elevated inflation relative to our target even before Covid. It was mostly in our tolerance band, i.e. somewhere between 2% and 3%, but it was above our target. We don’t target a band, we have a point target. We have long had an overheated labour market and very strong growth in property prices.

So, there are quite a lot of factors now being exacerbated by the new wave, which has merely accelerated the domestic trends. We think they are significant enough for us to decide for this forceful increase, in order to make it clear that this is something we don’t intend to put up with. In particular, we don’t intend to put up with entrenched expectations that inflation will no longer be around 2% as previously, but maybe twice as much. We can’t accept anything like that in our system, in which we target inflation and thus work with inflation expectations. We measure them in various ways – not ourselves, but the European Commission, the Statistical Office measure them, and there are also some surveys in industry – and we can see from those surveys that inflation expectations are unfortunately becoming unanchored from the stable level of around 2%. We are primarily reacting to that.

So, that’s the main reason that is convincing the majority. I have already spoken about the minority. I don’t want to interpret the views of these colleagues in any depth. I maybe wouldn’t do it correctly anyway, so it will be up to them to comment later.

I have a question about the sharp rise in market interest rates at the end of this year and the start of the next. To what extent does this sharp rise consist of today’s rate increase? In your view, how large a part of the rise is included in today’s decision? In other words, should we interpret today’s hike as a one-off step, as frontloading of what needs to be delivered, or is it a signal of what we can expect at the next two or more meetings?

The step we took today, which is no doubt exceptionally forceful, certainly represents a significant part of what we are calling a sharp rise in rates. However, as mentioned in the statement, we believe that we will unfortunately have to bring rates relatively quickly to the policy-neutral level, to use that ugly expression. Just to explain, this is somewhere around 3%, preferably above it. Given standard inflation, i.e. price growth of around 2%, this rate level guarantees a minimum real interest rate of somewhere around 1%.

We will certainly discuss increasing rates again at the meetings to come. I think there’s no doubt about that. It’s now hard to estimate the force of the future increases. It is clear that after the quite sizeable increase today, the tension due to the need to catch up with the forecasted rise will no longer be that strong. So I can imagine the following hikes certainly being smaller in nominal terms.

However, I want to stress that it’s not so much about the increase, the delta. Today we made a really exceptional increase in terms of the change. 125 basis points in one step is exceptional. But it’s all about the level. We affect the economy through the level of rates. After today the level will be 2.75%. So it’s not even at what we call the policy-neutral rate. Given how the situation is unfolding – which is also unprecedented as regards inflation, as we estimate it may reach around 7% at the end of this year or at the start of next year – the standard, neutral environment is too little for that. We will possibly have to create an even stronger effect so that we do indeed ensure a return to normal levels as soon as possible given our monetary policy horizon.

Simply speaking, we certainly covered a large part of the defined rise today, but it’s certainly not the last increase in the near future.

I want to ask to what extent the koruna exchange rate, which you don’t target, of course, plays a role in your considerations. If the koruna were to appreciate in line with your assumptions, it would be a faster, more effective instrument for taming inflation than interest rates. Are you considering the koruna in any way as an auxiliary or indirect tool to help you achieve the monetary policy target?

We naturally take the koruna exchange rate into account, as we are a small open economy. We don’t target it. It’s not an active instrument of ours in this respect. It’s a by-product, so to speak, of our monetary policy, which, however, we must take very seriously. As regards taming inflation, the exchange rate is of course a faster instrument. The pass-through to prices and the transmission mechanism is faster than for interest rates directly if we consider their effect excluding the exchange rate. So, we take that into account.

If the koruna exchange rate is in line with the forecast, however, it means that the other things are developing as forecasted. This means the exchange rate will not do the work for us if it develops in line with the forecast. In that case, the other assumptions of the forecast hold. Of course, if the exchange rate firms faster than in the forecast, it would to some extent accelerate the tightening of the monetary policy conditions and we perhaps would not have to tighten as much in our subsequent interest rate decisions.

One more thing about the tightening: maybe it’s not the best word to use, as I now realise, because we will still have negative real interest rates even after today. When we get back to our normal levels of inflation, hopefully sometime at the close of next year, only then will we be at the neutral rate.

You mentioned the koruna just now. I want to ask whether you discussed why the exchange rate in fact is not appreciating too much, even though it was visible after the previous meeting that rates would go up and the interest rate differential would widen, but the koruna is not reacting much. Do you have any signals, and did you discuss them, regarding this and the forex market?

Yes, we discussed these issues. We of course have various hypotheses. It’s definitely a multi-criteria issue. One thing that is probably temporary but may last for a while – relatively long – is that it seems the koruna is beginning to behave more like the standard currency of a new economy or emerging market. In the past, it reacted very sensitively to each rate increase or announcement of an increase. Now it reacts much less sensitively. Conversely, it is very sensitive to any appreciation of the large, stable currencies and their financial markets, the US dollar in particular, with investors leaving riskier positions in currencies like the Czech koruna and shifting, in expectation of higher returns, to dollars for example. I think this is what has been going on over the past few weeks. As you know, the US Fed – and in turn the analysts – has for some time been signalling a phase-out of quantitative easing in the USA and maybe a rate hike around mid-2022. We can see that the emerging market currencies in our region have weakened despite central banks raising rates to a lesser extent than us, or similarly to us. Today it was the Hungarian central bank, and yesterday also the Polish central bank, relatively significantly. Those currencies have mostly tended to depreciate. We have had a wider differential, and the koruna has been more or less stable. It perhaps hasn’t appreciated as much as expected, and has then even weakened slightly and then rebounded somewhat.

So, there’s this temporary but significant phenomenon. When there’s any great shift from higher to lower risk in terms of currency investment – in particular when the dollar appreciates – investors move to that destination and those currencies tend to depreciate.

As for the other things, there are still various hypotheses related to the size of our market and the relatively large amount of excess liquidity that accumulated at the time of the exchange rate commitment, i.e. what we used to call the overboughtness of the koruna. To some extent, this may be having an effect on the behaviour of the currency.

There’s also a new phenomenon, which I think is also temporary but may be playing a role in the eyes of some investors. For the first time in a long time – I can hardly remember the last time this happened – we’ll have a twin deficit this year. This means that, for the first time in a long time, we’ll have a balance of payments deficit – we’ll have a much worse trade balance result, a balance of payments deficit – and along with that we have an extremely high public finance deficit, looking, for example, at the structural deficit for solid comparability. Nominally, our general government deficit isn’t that high, but we have one of the highest structural deficits in the EU for this year. Few countries have such a high deficit in the context of the other parameters of the macroeconomic situation.

So, all these things taken together, it seems some partial explanations can be found for the lack of appreciation of the koruna. However, this certainly calls for a deeper analysis for the future. The time for that will certainly come. We’ll see.

In conclusion, Governor, could you sum up the dilemma that you may have – and that is apparent from the differences in the voting of the Bank Board – in that the same factors that are fuelling inflation and forcing you to react also seem to be undermining Czech economic growth and negatively affecting firms – the shortage of workers, the shortage of chips, the partially closed car plants and so on – and are thus cooling the economy a little. At first glance this may seem to be a contradiction. Could you please explain how you decide when you are targeting inflation on the one hand but are also meant to be taking care of the economy as a whole on the other?

Thank you for your question. This is, of course, a very serious issue. We discussed it at length and we discuss it constantly. We are very well aware that monetary policy is not neutral, particularly in relation to the distribution of income in the economy, that’s clear. Monetary policy is not painless. It comes at a cost. But we assess the dilemma very thoroughly and discuss it intensely. We always have to weigh the pros and cons.

Our mandate, clearly set out in the Constitution and the CNB Act, says that we primarily have to maintain price stability. It says this clearly and we have a commitment to do so. Our mandate also says that as long as we fulfil our objective, we have to take steps to support the government’s policy leading to economic growth and general prosperity. But the order is clearly expressed there: we simply must primarily maintain price stability.

We aren’t fools, of course. We know that we can achieve this reasonably, though always at a cost. This means that on no account do we do it at any cost. However, we know that there is always some cost linked with price instability. We always consider whether the cost of letting price instability run rampant is higher than the cost of reducing GDP by a percentage point for a limited period of time. We always compare this and try to find the optimal state.

We’re now seeing it as optimal – even at the cost of some cooling of the economy – to bring back stability in a reasonable period of time, and in particular to anchor expectations that we are always ready to maintain stability and always restore it as soon as possible. And this, of course, comes at a cost. That’s the order in which most of us think about this. I don’t think we can do it in any other way, as it’s not our job to take into special account any interest groups such as borrowers or the industrial sector of the economy and its exporters or importers.

Our job is to maintain price stability in this country, as science and history have shown us that price stability is a value in itself and is a necessary condition for maintaining sustained prosperity in this country. No government policy, however clever and sophisticated in its interventions in one direction or the other it may be, will ensure prosperity without price stability. If there’s no price stability, other things won’t work either. So the order of how we think is clear. But we are, of course, aware that this has some impacts. We weigh things up and decide accordingly.

My question is about the equilibrium interest rate. If I understood it right, last time you said that you see it at between 2.5% and 3%, but today you mentioned 3%. Does this mean that the lower part of the range is no longer relevant, or has nothing changed?

The politically neutral rate is nowhere defined to a specific decimal place or point on a scale. We aren’t exactly at the 2% target every month. The right result is when we are close to the target on average over a period of time. There’s always amplitude. The neutral rate therefore cannot be defined precisely.

I meant, of course, that, in my view, the rate must be at least above 2.5% for us to be able to say that we are approaching the neutral rate. It’s clear that the lower boundary of 2.5% is for times when inflation is below the target but is still acceptable and reasonable, somewhere between 1% and 2%. As for the upper one, we have a tolerance band with an upper and a lower boundary.

So let’s not consider this in too much detail. At this moment, it’s more important for us that, unfortunately, the situation is such that we will have to respond with a really forceful increase. I’m not saying that the rise will be as large again. But we’ll perhaps get above the neutral level from the perspective of normal inflation, as we’re responding to an abnormal situation and a large inflation swing. And it’s clear that the rate will stay at that level for some time afterwards.

After inflation stabilises and we know that it has stabilised sustainably, circumstances may gradually make us return to a rate closer to the neutral level of around 3%. So there’s no point in speculating. Let’s say that the corridor is 2.5%–3.5%. I don’t think it’s a mistake to say that. But it makes no sense to speculate about decimal places. Thank you.