Minutes of the Bank Board Meeting on 22 June 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 fourth situation report assessing the information obtained since the spring forecast was drawn up. Consistent with the baseline scenario of this forecast was a further sharp rise in market interest rates. The Bank Board assessed the risks and uncertainties of the spring forecast in light of the new information as being markedly inflationary and acting towards a need for further significant tightening of monetary policy.
In the course of the debate, the board members agreed that maintaining price stability was the Czech National Bank’s primary mandate. According to Jiří Rusnok, Marek Mora, Tomáš Nidetzký and Tomáš Holub, in a situation where inflation expectations were threatening to become unanchored from the inflation target it was extremely important to communicate effectively that the CNB was not abandoning its price stability mandate, accompanied by appropriate monetary policy actions. If inflation expectations really did become significantly unanchored from the 2% target, the costs of the subsequent disinflation would be much higher. A forward-looking monetary policy response was therefore necessary. Aleš Michl said that in his opinion, the three key conditions for bringing inflation down were (in order of importance): first, reduce the country’s level of debt; second, stabilise the repo rate at a higher-than-usual level; and third, don’t let wages be indexed to inflation.
According to Oldřich Dědek, who also did not question the price stability mandate, the current inflation was predominantly of a cost-push nature, lying beyond the reach of domestic monetary policy. In his view, moreover, this cost shock had brought the domestic economy close to stagflation, and a sharp hike in interest rates would exacerbate its negative impacts on economic activity. Tomáš Holub noted that dividing inflation into cost-push and demand-pull loses relevance in a situation of unanchored inflation expectations. It was meanwhile risky to rely on a scenario with an extended monetary policy horizon when there was a threat of unanchored expectations. Jiří Rusnok agreed, adding that inflation was seeping through the entire economy regardless of the initial shock and that monetary policy had to react. Marek Mora cast doubt on the predominantly cost-push domestic inflation story, referring to growth in prices of many goods in core inflation. He also noted that unemployment in the Czech economy remained low and that there were currently no signs of labour market cooling connected with a stagflationary shock.
The board members discussed the transmission of monetary policy. Marek Mora and Tomáš Nidetzký said that monetary policy transmission was functioning with the usual lag and that the past rate hikes would bear fruit in the form of a future decline in inflation. Marek Mora and Vojtěch Benda then referred to the Monetary Department’s simulation of hypothetically passive monetary policy over the past 12 months. According to this simulation, keeping rates flat at 0.25% over the past period would have led to inflation being 7 pp higher and the koruna being substantially weaker than the actual current level. According to Marek Mora and Vojtěch Benda, although the specific quantitative results of this simulation were subject to significant uncertainty, its qualitative message was indisputable. Conversely, Oldřich Dědek said that the relationship between interest rates and inflation may not be working in the standard way at the moment. In his opinion, the sharp increases in interest rates in a situation of rapidly rising cost-push inflation were contributing to growth in inflation expectations. According to Marek Mora, the argument that the interest rate increases were contributing to growth in inflation was a very minority one and he regarded it as wrong. Jiří Rusnok agreed with this assessment.
The weaker-than-expected exchange rate of the koruna in the second quarter to date was assessed as an inflationary risk of the spring forecast. The current account deficit was repeatedly mentioned as one of the reasons for the weaker koruna, as were the implemented and expected monetary policy actions of large central banks (the Fed and the ECB), which would narrow the interest rate differential. It was also said repeatedly that the financial market uncertainty regarding the new Bank Board’s commitment to raising interest rates if necessary could be putting depreciation pressure on the koruna. Some of the board members reiterated their opinion that scaling up sales of international reserves would facilitate a reduction in inflation. Vojtěch Benda proposed a return to regular sales of international reserves, though beyond the framework of returns; this would lead to the koruna strengthening above its equilibrium level and soften the impacts of the inflation pressures stemming from import prices. Against this, it was said that foreign exchange interventions do not have the long-run potential to strengthen the exchange rate below the market level. A majority of the board members agreed that the intention to curb excessive volatility of the koruna still applied in a situation of exceptionally high inflation.
Marek Mora and Tomáš Nidetzký said that the expected tightening by large foreign central banks would have an anti-inflationary effect in the medium term via a cooling of global demand. Another medium-term anti-inflationary factor was the deep decline in the real incomes of Czech households and firms and hence in domestic demand. According to Marek Mora, however, these factors were not very visible in the data so far.
New information regarding wage growth and GDP growth in the first quarter of this year were assessed from the perspective of the risks of the spring inflation forecast. According to Tomáš Holub, the automatic incorporation of this information into the GRIP should not be overestimated and should be the subject of a more detailed analysis in the forecast currently under preparation. In particular, the interpretation of wage growth was in his view somewhat complicated by a revision of the time series. He then said that there was currently no wage-inflation spiral on the labour market. However, he noted that if such a spiral started, it would mean that the opportunity for a monetary policy response had already been missed. It was therefore not possible to wait for clear evidence of the emergence of this spiral. Vojtěch Benda, Tomáš Holub and Marek Mora then drew attention to the inflationary risk of growth in wages and salaries connected with the political cycle.
Oldřich Dědek mentioned that the interest rate increases were raising the cost of government financing and that monetary policymakers should take this into account in their decision-making. In his opinion, this would be a show of healthy monetary and fiscal policy coordination. Against this, Vojtěch Benda noted that the costs of the existing public debt had not been directly affected by the current monetary policy measures and that the currently high inflation was reducing the ratio of public debt to nominal GDP. He then emphasised that the recent growth in public debt had not been caused by increased government interest costs due to monetary policy tightening, but by a loss of revenue due to the abolition of taxation of the super-gross wage.
The Board also devoted part of its debate to financial stability. Vojtěch Benda and Oldřich Dědek noted that the interest rate hikes had helped to cool the property market. According to Oldřich Dědek, the sharp increase in rates had been negatively reflected in a low quantity of new mortgages. Tomáš Holub and Tomáš Nidetzký commented that according to analyses drawn up during the preparation of the Financial Stability Report, the interest rate increases would not jeopardise the stability of financial system. Tomáš Nidetzký added that the quantity of new mortgages was not unusually low and reflected the extremely high volume of mortgages granted last year.
The board members assessed the severity of the monetary policy error of undertightening relative to that of overtightening at the present meeting. Marek Mora said that the error of overtightening was less severe, because policymakers could react to it by easing rapidly. By contrast, the error of undertightening in his view increased the risk of unanchored inflation expectations and hence also the costs of reducing inflation in the future. Oldřich Dědek would regard late recognition of the economic risks of the war in Ukraine – some of which (sharp growth in gas prices) were starting to materialise – as the biggest monetary policy error.
Tomáš Holub proposed that a consensus, unanimous rate increase smaller than that recommended by the Monetary Department and that preferred by the majority of the current Bank Board would be desirable in the interests of calming the financial markets and ensuring a smooth transition to the new Bank Board. This proposal was supported by a majority of the board members but was opposed by Aleš Michl and Oldřich Dědek.
At the close of the meeting the Board decided to increase the two-week repo rate by 1.25 percentage points to 7.00%. At the same time, it increased the discount rate by the same amount to 6.00% and the Lombard rate to 8.00%. 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. The Bank Board also decided to keep the CNB’s strategy of current foreign exchange interventions unchanged.
Author of the minutes: Jan Brůha, Monetary Department