Minutes of the Bank Board Meeting on 3 November 2022

Present at the meeting: Aleš Michl, Marek Mora, Eva Zamrazilová, Oldřich Dědek, Tomáš Holub, Jan Frait, Karina Kubelková.

The meeting opened with a presentation of the seventh situation report and the new macroeconomic forecast. In the baseline scenario, inflation would increase above 18% in 2022 Q4. It would then start to decline rapidly, due to diminishing growth in costs, cooling external demand and the previous tightening of domestic monetary policy. At the monetary policy horizon – in the first half of 2024 – inflation would return close to the CNB’s 2% target. Consistent with the baseline scenario of the forecast was a rise in market interest rates initially, followed by a gradual decline in the course of next year.

The Board assessed the risks and uncertainties of the baseline scenario of the forecast as being significant and going in both directions. The upside risks to inflation included faster wage growth, more expansionary fiscal policy and a higher outlook for foreign producer prices. The threat of inflation expectations becoming unanchored and the related risk of a wage-price spiral remained significant risks in the same direction. By contrast, the growing likelihood of recession in the Czech Republic and abroad and hence a stronger-than-forecasted slowdown in domestic consumer and investment demand were downside risks. The introduction of additional measures to limit growth in energy prices at the domestic or European level and a faster-than-expected decline in core inflation were additional anti-inflationary risks. The general uncertainties of the outlook included the future course of the war in Ukraine, the availability and prices of energy, and the future monetary policy stance abroad.

Aleš Michl opened the meeting by saying he preferred to keep interest rates unchanged, because growth in the quantity of money in the economy was slowing significantly. The year-on-year change in net new mortgages had been -82% and that in net new loans to businesses ‑64% in September. However, keeping rates unchanged was contingent on responsible fiscal policy and moderate wage bargaining demands. According to Aleš Michl, interest rates would for some time remain higher than they had normally been in the past ten years or so. He called on the other board members at this time of extreme uncertainty to express their expert opinion and not vote mechanistically according to the output from the model.

In a discussion of the risks arising from abroad, the Board concurred that the anti-inflationary risk of a global recession had increased further. Karina Kubelková said that the new forecasts were gradually revising GDP growth rates down not only in the Czech Republic’s main trading partners, but across the entire global economy. In this context, Jan Frait noted that lower economic activity around the world usually leads to a decline in commodity prices and hence to a weakening of global inflationary pressures. Jan Frait identified the elevated stress now visible in financial markets and asset markets in many countries as another potential global source of anti-inflationary pressure. In the next part of its debate, the Board focused on the domestic real economy. There was a consensus that the new incoming data were indicating a cooling of economic activity amid quite a deep decline in households’ real income and consumption. Repeated mention was also made of the flash GDP estimate for Q3, which, in line with the forecast, was indicating a quarter-on-quarter contraction of 0.4%. The Czech economy would therefore probably find itself in recession in the near future. Marek Mora identified developments on the labour market as a large unknown. As Eva Zamrazilová had also said, the labour market was cooling as well. Nonetheless, in his opinion it was far from certain that the projected economic slowdown would lead to inflation returning quickly enough to the CNB’s 2% inflation target without further monetary policy tightening. Tomáš Holub shared this view.

The board also discussed domestic price developments. According to Oldřich Dědek, the observed data on the domestic economy and core inflation confirmed the hypothesis of strengthening fundamental disinflationary pressures. In his view, prices of energy and food were clearly the biggest contributors to the rising inflation. Both these items, in his opinion, were outside the control of domestic monetary policy. Karina Kubelková also said that the cost shock had probably not yet entirely subsided, but on the contrary threatened to escalate further. Against this, Tomáš Holub noted that a significant part of the domestic core inflation consisted of demand factors, which had even outweighed supply ones in some previous quarters. On top of that, the threat of inflation expectations becoming unanchored persisted.

A majority of the board members nonetheless felt that, according to the observed data from the economy, the high inflation was not yet causing inflation expectations to become unanchored or a wage-price spiral to emerge. Eva Zamrazilová, Oldřich Dědek and Karina Kubelková said these risks had even decreased slightly, partly because of worsening data from the real economy and firms’ concerns of an impending recession. Firms would have only limited room to increase wages. This would lead to a decline in the real consumption expenditure of households. In this context, Eva Zamrazilová added that, according to economic theory, if increased inflation expectations cannot pass through to an acceleration in expenditure, they cannot feed through to actual inflation either. In her view, moreover, analysts’ expectations generally show signs of cyclical behaviour, and the probability of catching a turning point is low. She and Oldřich Dědek also pointed out that even after three months of interest rate stability, financial market analysts’ inflation expectations were virtually unchanged – and had even fallen slightly since September – at both the one-year and three-year horizon. In their view, the current policy of keeping interest rates unchanged was therefore not leading to any unanchoring of inflation expectations. However, Tomáš Holub noted that the inflation expectations of corporations and households were stable at substantially higher levels and the wage growth forecast had been revised upwards on the basis of the observed data. Against that, neither Eva Zamrazilová nor Oldřich Dědek regarded the year-on-year nominal wage growth of around 7% at the forecast horizon as in any way alarming given the substantial drop in real wages. In this context, Marek Mora and Tomáš Holub pointed out that it would be too late when the manifestations of unanchored inflation expectations became clearly visible. Oldřich Dědek therefore recommended arguing for, and pointing to the need for, moderate wage growth, since he regarded it as unrealistic to rein in wage demands by raising interest rates.

In the Board’s debate on the current and future monetary policy stance, Marek Mora and Tomáš Holub said that, given the political reality and rising budget deficits, it was evident that fiscal policy would be more expansionary than previously declared for the next year at least. Another short-term upside risk to inflation they identified was the rapid interest rate increases of the ECB and the Federal Reserve, which could exert strong depreciation pressure on the koruna. According to Oldřich Dědek, however, this potential risk was not showing up in the exchange rate at present. A majority of the Board also agreed that the synchronised tightening of monetary policy around the world could have synergistic effects, leading to generally excessive tightening and a global anti-inflationary effect. Eva Zamrazilová, Jan Frait and Karina Kubelková also noted that the growth in interest rates abroad was also leading to an increase in long-term domestic interest rates at the longer end of the yield curve and hence to tighter domestic financial conditions, despite short-term interest rates being flat. Tomáš Holub said it was appropriate to react preventively to the risk of a possible weakening of the exchange rate due to the narrowing interest rate differential vis-à-vis the rest of the world. He drew attention to the potential for a faster and stronger pass-through of the exchange rate to prices than there usually is in a low-inflation environment. Marek Mora meanwhile said that raising interest rates would confirm their role as the main monetary policy instrument. By contrast, Karina Kubelková regarded keeping interest rates unchanged as a justified and defendable step in the current situation of extreme uncertainty, with no loss of central bank credibility. Eva Zamrazilová added that, given the usual lag, an interest rate hike now would hit an economy running well below its potential in 12 months’ time. She would regard this as too high a price for the national economy to pay for the potential benefits of 0.5 percentage point lower inflation. Jan Frait identified the potential impact of the interest rate increases by large central banks on the exchange rate of the koruna as a relevant argument. He nonetheless argued for a patient approach, as he regarded it as quite likely that large central banks would ultimately not deliver fully on their current fairly strong hawkish rhetoric, not only as regards interest rates, but also in terms of reducing their balance sheets.

Part of the Board’s debate focused on financial stability. The board members repeatedly mentioned the sharply falling demand for new koruna loans, most notably mortgages. Eva Zamrazilová and Oldřich Dědek also drew attention to the rising share of euro-denominated corporate loans, which they attributed to the high domestic interest rates. Jan Frait predicted that the downward trend in new mortgages would continue. In time, this would be reflected in a price correction on the housing market, where some rigidity and low trading activity was currently apparent. He also said that interest rates on koruna loans were now quite high and were also above the neutral rate. This was being reflected in projects and mergers and acquisitions being cancelled and was thus having a desirable restrictive effect on the economy.

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 0.75 percentage point. The Czech National Bank will continue to prevent excessive fluctuations of the koruna.

Author of the minutes: Martin Motl, Monetary Department