Minutes of the Bank Board Meeting on 31 March 2022

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 second situation report, underpinned by an assessment of the currently available information, which related largely to the economic impacts of the war in Ukraine. The war had significantly changed the outlooks for the foreign and domestic variables included in the winter forecast. Consistent with the winter forecast had been a substantial rise in market interest rates, followed by a gradual decline from the second half of this year onwards.

The Board assessed the risks and uncertainties of the winter forecast as being markedly inflationary, especially in the short run. These risks also required significantly tighter monetary policy, and probably for longer. A majority of the board members continued to regard the strong domestic demand, bolstered by a long-overheated labour market, as a significant source of domestic price growth. Jiří Rusnok said that the underlying inflationary factors had been forming for a long time and the second-round effects in the price vertical were clear. Monetary policy had to respond actively to these domestic inflation pressures, which were not diminishing. Marek Mora, Tomáš Nidetzký, Vojtěch Benda and Tomáš Holub agreed. However, the cost pressures from the external environment were also growing significantly. These included in particular a sharp rise in prices of energy and commodities.

The board members emphasised that we were in a situation of unprecedented growth in uncertainty, which, from a monetary policymaker’s perspective, was even greater than it had been at the outbreak of the Covid pandemic. Tomáš Holub and Marek Mora said that if the Russian invasion of Ukraine had hit the Czech economy in the steady state, it would have been a typical inflationary shock, one whose first-round price impacts could have been disregarded. The appropriate response would then have been to focus solely on its second-round effects. However, the economy had been hit by the shock in a situation of high, broad-based inflation where there was a need to maintain the CNB’s monetary policy credibility.

Oldřich Dědek and Aleš Michl said jointly that the outbreak of the war in Ukraine constituted a structural shift that was making the policy of raising interest rates sharply even more problematic. In their view, the predominantly cost-push nature of the present inflation, now exacerbated by the war, would continue to make it impossible to subdue inflation with the use of interest rates. At the same time, raising interest rates would exacerbate the decline in economic output. According to Aleš Michl, two anti-inflationary measures were now needed: a gradual reduction in the government budget deficit and the prevention of indexation of wages to inflation. The board members agreed that it was not possible to declare the inflation pressures to be purely cost-push in nature and to abandon monetary policy.

There was a consensus that the economic consequences of the war and the economic sanctions against Russia would be stagflationary. The key question according to Marek Mora was to what extent would the economic slowdown have an autonomous anti-inflationary effect, or what would be the resulting combination of anti-inflationary demand and inflationary supply factors. He noted that the dramatic decline in GDP seen during the coronavirus pandemic had not had an anti-inflationary impact. Vojtěch Benda said that the expected additional fiscal expenditure of the Czech government connected with the influx of refugees could be inflationary. According to Tomáš Holub, the tightness in the domestic labour market could be partially reduced by the effect of additional labour force in the form of war refugees, albeit selectively in only some sectors. Tomáš Nidetzký pointed out that the first signs of a deterioration in consumer and investment sentiment were already appearing, and the monetary policy question was whether, given the length of the transmission mechanism, it still made sense to respond with another sizeable rate hike.

A large part of the debate was devoted to the anchoring of inflation expectations. According to Vojtěch Benda, this anchoring could be weakened if the central bank failed to send out strong enough signals that monetary policymakers intended to fight inflation and fulfil their mandate. Tomáš Holub said that some unanchoring of inflation expectations was already apparent in firms’ pricing. Instead of dampening the impacts of the cost shocks in the usual way, manufacturing and retail chains were currently amplifying them by preventively increasing their profit margins. According to Tomáš Nidetzký, the maintenance of inflation expectations could also be put at risk if the koruna started to weaken without fundamental cause. In such case, it would be appropriate to curb excessive exchange rate volatility. Conversely, Oldřich Dědek felt that the sizeable decline in real wages and the harsh impacts of the energy crisis on firms and households would prevent a wage-price spiral from forming. 

Several of the board members commented on the effectiveness of the monetary policy transmission mechanism. Oldřich Dědek and Aleš Michl argued that the previous interest rate hikes had not had an impact on the inflation rate, primarily because monetary policy was unable in the short term to influence the cost shocks underlying the higher inflation. By contrast, Marek Mora and Jiří Rusnok emphasised that the sharp rise in interest rates had de facto not started until last autumn, so its effects – given the horizon of most effective transmission – would only be visible after 4–6 quarters, i.e. at the end of this year.

Part of the Board’s discussion focused on the exchange rate. It was said that the CNB’s foreign exchange market interventions against the rapid depreciation of the koruna after the outbreak of the war in Ukraine had done their job and no interventions had been needed for some time now. After a discussion, the Board therefore decided to resume the CNB’s activities under the programme of sales of part of the income on international reserves, which had been suspended while its foreign exchange market interventions had been going on. The Board also debated the potential use of the exchange rate in an effort to subdue inflation. Jiří Rusnok said that in this situation, we should not dismiss thoughts of using the exchange rate channel, because the interest rate channel would not suppress inflation sufficiently quickly on its own. Vojtěch Benda agreed. Conversely, the other board members said they did not feel the need to use the exchange rate as an additional monetary policy instrument alongside the standard one (interest rates).

In view of the aforementioned factors, a majority of the Board felt it was necessary to respond to the further marked increase in inflation pressures in the Czech economy. At the same time, the direct impacts of the war in Ukraine on consumer prices could be partially disregarded for the time being. However, monetary policy would react to the indirect price effects of these pressures, ensuring that inflation returned to the 2% target in the longer run. The Board therefore also said that it was ready to continue raising interest rates so that inflation expectations did not diverge from the CNB’s 2% inflation target in the longer term. Restoring price stability soon was now the CNB’s absolute priority, because this was a necessary condition for long-term prosperity of the Czech economy.

At the close of the meeting the Board decided to increase the two-week repo rate by 50 basis points to 5%. At the same time, it increased the discount rate by the same amount to 4% and the Lombard rate to 6%. 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