Minutes of the Bank Board meeting on 21 June 2023

Present at the meeting: Aleš Michl, Jan Frait, Eva Zamrazilová, Tomáš Holub, Karina Kubelková, Jan Kubíček, Jan Procházka.

The meeting opened with a presentation of the fourth situation report based on an assessment of the information obtained since the spring forecast was drawn up. The Board welcomed the decline in inflation that had occurred in the past period, which had been slightly faster than forecasted in its core component and in food prices. It was also said repeatedly that this decline in inflation did not mean final victory and that monetary policy must not relent in its efforts to reduce inflation to the 2% target.

The Bank Board assessed the risks and uncertainties of the outlook as being significant and going in both directions. Still expansionary fiscal policy was having an inflationary effect. The threat of inflation expectations becoming unanchored and the related risk of a wage-price spiral also remained risks in the same direction. By contrast, a further stronger-than-forecasted downturn in domestic consumer and investment demand was a downside risk. 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.

Part of the discussion concerned the risk of a wage-price spiral. According to Eva Zamrazilová, this risk had decreased substantially since the last meeting. Jan Kubíček said the new data were not indicating the materialisation of this risk for the time being. Against this, Karina Kubelková and Tomáš Holub noted that the lower-than-forecasted year-on-year wage growth reflected a revision of the historical time series, quarter-on quarter wage growth remained rapid, and such high wage growth remained an upside risk to inflation. In this connection, Tomáš Holub added that growth in nominal unit wage costs had reached a record high. Jan Procházka noted that wages had already been adjusted in the majority of firms for this year, so an interest rate increase would not have any effect on wage growth this year. Aleš Michl commented that the central bank had set a good example as regards wage restraint for the rest of the economy with its agreement on wage growth at the CNB, i.e. by cancelling the inflation clause.

Jan Frait and Jan Procházka assessed the labour market as tight, more for structural than cyclical reasons. According to Jan Frait, there was a risk that those reasons could hinder the long-term attainment of the 2% inflation target. A strong exchange rate of the koruna could significantly contribute to mitigating that risk. In the opinion of Jan Procházka, the tightness in the labour market ruled out any interest rate cut at the moment. Karina Kubelková agreed that the labour market was tight. In her view, monetary policy should react to the tightness in a forward-looking manner. Tomáš Holub said the risk of more inertial wage growth in the future was increasing together with the resurging labour market tightness. By contrast, Jan Kubíček stated that he saw the year-on-year growth in unemployment and year-on-year decline in vacancies as indicators of gradually diminishing tightness in the labour market.

According to Karina Kubelková, the inflationary risk stemming from the evolution of profit margins persisted. She added that if significant repricing were to occur in January 2024, it could jeopardise the fulfilment of the inflation target next year.

Eva Zamrazilová assessed inflation expectations as adaptive. In her opinion, they would decrease as inflation came down. Jan Kubíček agreed with the adaptive nature of inflation expectations and noted that they were falling. Despite the uncertainty associated with measuring them, this meant that the risk of them becoming unanchored was decreasing. Against this, Tomáš Holub pointed out that the scenario of increased inflation expectations drawn up in the spring forecast had also assumed a gradual decline in inflation expectations. However, this scenario had implied a recommendation to increase rates further, so in his opinion it was premature to talk about this risk fading.

A large part of the discussion concerned the effect of fiscal policy on inflation. According to Aleš Michl, to return inflation to sustained low levels it was now necessary to reduce the country’s pace of borrowing. Jan Frait and Jan Procházka also evaluated the nature of fiscal policy as inflationary and the final extent of the fiscal consolidation currently under discussion as uncertain. Karina Kubelková and Tomáš Holub also referred to fiscal policy as an inflationary factor in the short term, especially in the context of the expected price effects of increases in indirect taxes. By comparison with these price effects, the consolidation measures would have an anti-inflationary effect in the longer run.

According to Aleš Michl and Jan Procházka, the current interest rate level was dampening domestic demand. Jan Kubíček said that the evolution of domestic demand was a downside risk to inflation and noted that aggregate domestic demand had fallen by almost 5% year on year in real terms and the Czech economy would have been in a deep recession if not for the highly positive contribution of net exports. Conversely, Tomáš Holub said that a faster-than-expected renewal of consumer demand, coupled with a sharper decline in the saving rate, could be a significant upside risk to inflation.

Some of the board members discussed developments abroad. Jan Procházka assessed the effect of the external environment on domestic inflation and monetary policy as mixed. There was a risk of demand cooling significantly in China. This would foster a reduction of domestic rates via a negative effect on external demand for exports of Czech products. Jan Frait noted that further interest rate hikes by inflation-targeting central banks “acting collectively” could significantly cool external demand by tightening financial and credit conditions. This would have an anti-inflationary effect on the Czech economy. More forceful interest rate hikes abroad could simultaneously exert upward pressure on domestic monetary policy rates, reducing the risk of the koruna weakening. Eva Zamrazilová said that a further hike in rates by the ECB would increase the cost of foreign currency loans for the domestic corporate sector and hence affect the part of the credit transmission channel that domestic monetary policy cannot reach. An increase in ECB interest rates would therefore further dampen domestic demand, especially investment demand, and, as a result, would have an anti-inflationary effect.

The board members discussed the future path of interest rates. According to Aleš Michl and Jan Frait, a hike at a future meeting could not be ruled out if key central banks continued to increase their monetary policy rates and inflation appeared to be persistent. Eva Zamrazilová said it was too soon to seriously discuss lowering rates. Jan Procházka said that starting the rate reduction cycle prematurely could revive domestic demand too much and hence lead to a need to raise rates next year. A majority of the board members agreed that interest rates would remain at current or higher levels for longer. According to Tomáš Holub, this meeting was the last chance to raise rates in this inflation episode, then the only viable strategy would be to keep them “higher for longer”, which, however, he regarded as suboptimal as regards the extent and timing of the decline in inflation.

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, Jan Frait, Eva Zamrazilová, Jan Kubíček and Jan Procházka. Two members, Tomáš Holub and Karina Kubelková, voted for increasing rates by 0.25 percentage point. The Czech National Bank will continue to prevent excessive fluctuations of the koruna.

Author of the minutes: Jan Brůha, Monetary Department