Minutes of the Bank Board meeting on 20 March 2024

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

The meeting opened with a presentation of the second situation report based on an assessment of the information obtained since the winter forecast was drawn up. Consistent with the forecast was a rapid decline in market interest rates in the course of this year.

Aleš Michl began by saying that price stability had been restored in the Czech Republic. Developments to date and the inflation outlook allowed the CNB to continue reducing interest rates cautiously. To maintain inflation at the target level, though, it was necessary to keep monetary policy tight until the core component of inflation was fully under control. The strategy of lowering rates cautiously would allow the CNB to interrupt or halt the decline in rates at still restrictive levels if the need arose. According to Aleš Michl, the neutral monetary policy rate would be higher than in the past. The board members said repeatedly that interest rates were now clearly restrictive, helping to extinguish the last embers of inflation in the Czech economy.

The Board assessed the risks and uncertainties of the winter forecast as being modestly inflationary. Most of the significant risks and uncertainties identified at the February meeting meanwhile persisted. They included a slower decline in the elevated inflation expectations, which, given the tight labour market, could be reflected in stronger wage demands. According to Karina Kubelková, a moderate upswing in wage growth could lead to a stronger recovery in household consumption. The published data on retail trade at the turn of the year might also be presaging such a development. According to Jan Frait, the observation that employees in some sectors in neighbouring countries, with which the Czech economy is closely interconnected, were exerting strong pressure for wage compensation for the past inflation shock, was further evidence of upside risks to inflation. In this context, Tomáš Holub assessed the current wage growth as rather higher than would be consistent with the fulfilment of the 2% inflation target in the medium term, but after two years of exceptionally high inflation, and with unemployment still low, it could be described as relatively subdued overall. Jan Procházka viewed wage growth as a minor risk of the forecast in light of the available data on corporate earnings and the very subdued industrial production.

Part of the debate was devoted to the exchange rate of the koruna, which was rather weaker than the winter forecast had assumed. According to Jan Kubíček, the exchange rate was thus fostering monetary policy easing for the first time in quite some time. He would not overestimate the current stabilisation of the rate for now, in view of the depreciation episodes seen in the past. Eva Zamrazilová conversely did not regard the current exchange rate as a significant risk to the fulfilment of the target in the long term. Nonetheless, the evolution of the rate, along with the inflation readings, would be an important factor for her in the decision-making at future meetings, as it would be for Karina Kubelková. Jan Frait described the risk of a sustained weakening of the koruna as unlikely given the evolution of long-run fundamentals.

The board members also mentioned a number of other risks. A stronger-than-expected downturn in global economic activity and weaker German economic output were fostering lower inflation. On this, Karina Kubelková noted that, according to analyses, the Czech economy was very closely interlinked with the German one, so the pass-through of the recession in Germany to the domestic economy could be quite fast. In the discussion of the external environment, Tomáš Holub and Jan Procházka said that the risk of a later start to interest rate cuts by the ECB and the Fed was beginning to materialise slowly, with a potential depreciation effect on the koruna.

The Board also discussed the current data on domestic inflation, the decline in which had been deeper than forecasted. Jan Kubíček mentioned that one-third of the deviation had been due to statistical effects. Eva Zamrazilová said that the drop in inflation to 2% in February had been aided to a large extent by a decrease in food prices, while the continuing rise in services prices was grounds for caution and for lowering rates gradually. Karina Kubelková agreed. Against this, Jan Frait and Tomáš Holub - while conceding the need to monitor the services segment closely - recommended analysing price sub-indicators on a long-term and interconnected basis. According to Jan Procházka, consumers were quite price sensitive, so prices were unlikely to be raised very significantly in the service sector.

A large part of the discussion was devoted to the extent to which monetary should be eased. Newly available indicators were pointing towards higher rates than in the baseline scenario of the current forecast over its entire horizon. In the debate, a majority of the board members' emphasised the upside risks to inflation at the forecast horizon and the effort not to surprise the financial market. They were therefore inclined to take a cautious approach to lowering interest rates, that is, to lower them by the same amount as at the February meeting (by 0.50 percentage point). Jan Kubíček felt that a more even rate path was more understandable for the market given that the model-based path was currently very volatile. Moreover, if the CNB's idea about the real equilibrium interest rate and, with it, the neutral monetary policy rate were going to move upwards in future forecasts as a result of ongoing analyses, the overall rate cut needed would not be so large. Jan Procházka had a similar assessment of the situation.

By contrast, Jan Frait recommended lowering interest rates by 0.75 percentage point, as he had done in February, due to the pricing in of the substantial fall in monetary policy rates in market rates, the subdued domestic demand, the worse outlooks for relevant foreign economies and the relatively high interest rates on koruna-denominated loans to non-financial corporations. Tomáš Holub was also now in favour of the same step, mainly because in recent months, the Board had been communicating that it would be applying a monetary policy approach based on assessing new incoming data. The favourable published figures on inflation and its core component were meanwhile indicating no reason to remain "behind the curve" with rates. In his opinion, another argument for reducing rates faster was the restrictive fiscal policy this year, which meant that monetary policy did not have to be kept so tight. Aleš Michl said that the current government budget deficits were not compatible with achieving the inflation target in the long term.

At its meeting, the Bank Board lowered the two-week repo rate by 0.50 percentage point to 5.75%. At the same time, it lowered the discount rate by the same amount to 4.75% and the Lombard rate to 6.75%. Five members voted in favour of this decision: Aleš Michl, Eva Zamrazilová, Karina Kubelková, Jan Kubíček and Jan Procházka. Two members, Jan Frait and Tomáš Holub, voted for reducing rates by 0.75 percentage point.

Author of the minutes: Jan Syrovátka, Monetary Department