Minutes of the Bank Board Meeting on 4 August 2022
Present at the meeting: Aleš Michl, Eva Zamrazilová, Marek Mora, Oldřich Dědek, Jan Frait, Tomáš Holub, Karina Kubelková. Minister of Finance Zbyněk Stanjura was present at the meeting.
The meeting opened with a presentation of the fifth situation report and the new macroeconomic forecast. In the baseline scenario of the forecast, the monetary policy horizon had been shifted to 18–24 months ahead due to extraordinary cost pressures amid exceptionally high uncertainty. According to the baseline scenario, inflation would rise further in the coming few months, reaching around 20% in the autumn, and should decline to around 2% in a year and a half. Consistent with the baseline scenario was stability of market interest rates initially, followed by a gradual decline next year.
The Board assessed the risks and uncertainties of the baseline scenario of the forecast as being significant and going in both directions. A further rise in commodity prices, a threat of inflation expectations becoming unanchored, a related risk of a wage-inflation spiral and easier fiscal policy were upside risks to inflation. By contrast, the growing likelihood of recession abroad and a stronger-than-forecasted downturn in domestic consumer and investment demand were downside risks. The general uncertainties of the outlook included the future course of the war in Ukraine, the availability and prices of energy, the future monetary policy stance abroad and the duration of the disruptions to global supply chains.
According to Aleš Michl, the CNB’s interest rates were at a level that was dampening domestic demand pressures. They were slowing growth in bank loans to households and firms and hence also in the quantity of money in the economy. Eva Zamrazilová said that the past interest rate increases had cooled demand for loans, but the latest – June – data on loan volumes and interest rates did not so far reflect the latest leap in the repo rate from 5.75% to 7%. She also said that the increase in the interest rate differential had manifested itself in the business sector as an increased share of foreign currency loans. This was weakening the transmission of domestic monetary policy and could pose a risk to the stability of the financial system. In her opinion, in a situation of extreme uncertainties it would therefore be rash to continue raising rates sharply. Karina Kubelková said that there were signs that the past rate increases were now cooling domestic demand and inflation, so caution should be exercised in setting interest rates. Jan Frait felt that thanks to the firm and bold approach of the previous Board the current rate level was relatively high. It was dampening demand for loans, which in turn was fostering a decline in consumption and investment demand, so caution could be exercised in setting interest rates. According to Marek Mora and Tomáš Holub, it was true that the previous rate increases were now being reflected in a cooling of demand and inflation. However, it would be premature to end the rate increasing cycle in a situation of high inflation. This was because of the risk of inflation expectations becoming unanchored and because most of the new information coming from the domestic and external economy was still inflationary in nature. In their opinion, therefore, the right course of action was to continue raising interest rates sharply. However, Tomáš Holub suggested that as a signal of monetary policy continuity, a consensus rate increase even of smaller magnitude than he preferred personally would be desirable. Marek Mora was willing to support such a consensus.
The Board agreed that long-term price stability was also contingent on moderate wage bargaining demands and responsible fiscal policy. According to Tomáš Holub, however, in this area the CNB was limited to making a general appeal, since fiscal policy and wage bargaining were both outside its remit. The CNB should therefore contribute to price stability with specific monetary policy action. Marek Mora mentioned that the election cycle could hinder efforts to achieve wage restraint and fiscal consolidation.
The Board discussed the risk of long-term inflation expectations becoming unanchored from the CNB’s target. According to Marek Mora and Tomáš Holub, this risk was acute and needed a firm monetary policy response. In this situation, Tomáš Holub did not support lengthening the monetary policy horizon in the forecast, as it could foster an increase in inflation expectations and wage demands. On the other hand, Eva Zamrazilová and Oldřich Dědek said that the surveys used to identify unanchored inflation expectations were unreliable. The only reliable evidence of unanchored inflation expectations would be the start of a wage-inflation spiral. However, there was no evidence for the materialisation of this risk at the moment. In their view, the materialisation of the risk of inflation expectations becoming unanchored would probably be counteracted by the drop in households’ real incomes and firms’ worsening situation linked with the growth in costs and the slowdown of the global economy. According to Oldřich Dědek, moreover, the already long-running combination of sharp interest rate increases and rapidly rising inflation was itself contributing to growth in inflation expectations.
Karina Kubelková and Jan Frait mentioned the signals of cooling global economic activity, which represented an anti-inflationary factor. Jan Frait pointed to the potential turnaround in the global financial cycle and the growing risk of an economic deterioration in emerging economies. In his opinion, this was another reason for proceeding cautiously and not raising rates at the current meeting. On the other hand, Jan Frait said that if large central banks in other countries did not deliver the expected tightening, it would mean continued global monetary and financial imbalances, which was an inflationary risk for the Czech economy. Tomáš Holub also said there were signs of cooling global demand, some commodity prices had corrected, and there were indications that the global supply chain issues were receding. Despite this, he felt it would be premature to end the domestic monetary policy tightening phase.
The Board also discussed the future interest rate path. A majority of the members agreed with the rate path in the baseline scenario, implying stability of rates at an elevated level for longer, and preferred it to a rate increase at this meeting followed by a decrease next year. Eva Zamrazilová said she was prepared to vote for a rate increase at a future meeting if evidence of a wage-price spiral emerged. Jan Frait said that if the expected cooling of domestic demand did not happen he was prepared to vote for a rate increase at a future meeting.
The Board went on to discuss the causes of the current high inflation. According to Oldřich Dědek, the dominant cause was an exogenous cost shock, which monetary policy was mostly powerless to dampen. Eva Zamrazilová and Jan Frait said that the current high inflation had also been caused, among other things, by excessively easy monetary policy over the past ten years. Monetary policy should be tighter on average in the long term than it had been over the past ten years. It was also said that the exchange rate commitment of 2013–2017 had caused the banking sector’s balance sheet to grow and hence contributed to the current high inflation. Tomáš Holub disagreed with this argument, pointing to the high balance sheet growth in Switzerland, which meanwhile had the lowest inflation in Europe.
The Board also discussed the reliability of the core forecasting model in a situation of extreme uncertainty. According to Eva Zamrazilová and Jan Frait, the core forecasting model was not providing an entirely adequate guide to setting interest rates in the present situation. On the other hand, Marek Mora noted that the high inflation and very low unemployment rate justified a rate increase in the present situation regardless of the reliability of the model forecast. Tomáš Holub also argued that the need for a further rate hike did not depend on the macroeconomic model used. He pointed to the high macroeconomic costs of the disinflation in the United States in the early 1980s, which had been caused by previous monetary policy inaction.
At the close of the meeting the Board decided to leave interest rates unchanged. The two-week repo rate remains at 7%, the discount rate at 6% and the Lombard rate at 8%. Five members voted in favour of this decision, Aleš Michl, Eva Zamrazilová, Oldřich Dědek, Jan Frait and Karina Kubelková. Two members, Marek Mora and Tomáš Holub, voted for increasing rates by one percentage point.
Author of the minutes: Jan Brůha, Monetary Department