Transcript of the introductory statement from the press conference - 23 June 2011

VICE-GOVERNOR

I am sure that you have already heard the result of the vote. The CNB Bank Board decided at its meeting today to leave the repo rate unchanged at 0.75%. Five Board members voted for this result, and two members voted for increasing rates by 0.25 percentage point.

What were the reasons for today’s decision of the Bank Board? First of all, the basic thing for which the CNB is responsible: according to our still valid forecast published six weeks ago, both headline and monetary-policy relevant inflation at the monetary policy horizon are very close to the inflation target, which is set at 2%. It is a good idea to repeat what is consistent with the forecast published six weeks ago, which remains valid as I said; consistent with this forecast is broad stability of market interest rates in the near future, and the forecast expects them to rise gradually from 2011 Q4. The risks to the forecast, and now I will speak above all about monetary-policy relevant inflation, were assessed as balanced today. It is perhaps fair to say that external developments were assessed as the most significant downside risk to inflation, and I will explain why and which risk we regarded as the strongest using the following charts. On the other hand, current inflation is an upside risk, especially as regards food price developments, and now I say this above all about headline inflation, or monetary-policy relevant inflation as risk-neutral. As for headline inflation, it was also discussed whether perhaps we do not see an upside risk to inflation, especially with regard to the increase in VAT – I will get back to this at the end, as we already had this at the Bank Board as an alternative scenario to the current forecast six weeks ago.

Now for the current forecast and the actual data. The forecast was published six weeks ago, and as I said, current inflation, which was published as a new piece of information since then, is 0.3 percentage point above our forecast. This is due mainly, as I said, to higher food prices, but on the other hand it is affected, I would say, by lower growth in administered prices and fuel prices than expected in the forecast. I will stick with the topic of food prices for a while, to have a look at how our experts perceived them in their presentation at the Bank Board meeting. It was showed using historical experience that after all we can always observe that food prices do not have to change immediately if inflation pressures exist, but once they accumulate, a sudden change in food prices occurs, especially for some items, and we think this was the case in this part, or rather at this moment. We will see whether food price inflation remains moderate or whether it will continue to surprise us in higher inflation, in the inflationary direction; therefore we assessed this today as an upside risk to inflation, and we will see how it develops further.

And now for the external environment. Here we compare, as usual, the Consensus Forecasts survey available at the time of the forecast and the new one available today. Of the four basic variables we take over for our forecast and the assessment of risks and current inflation developments compared to the forecast, if you look at consumer prices, there is almost no change, especially in 2012, a very small change of 0.1 percentage point for producer prices, a very small change in GDP, but we assessed the 3M EURIBOR as the most important change compared to the forecast, with a marked decline in rates abroad of up to 0.6 percentage point in 2012, which is important information for us, as we forecast inflation for 1–1.5 years ahead. Therefore we currently assess this as a downside risk to inflation in terms of the current forecast.

Here are two more variables which we take over from the Consensus Forecasts, the prediction for Brent oil prices, which is little changed. A change in the Consensus Forecasts can be observed for the USD/EUR exchange rate, where the evolution, or the change, is towards a weaker dollar, by almost 3%, but we do not attach as high a weight to this in the forecast as to the 3M EURIBOR, for two reasons: the exchange rate is more volatile than interest rates, and in our model we are much more sensitive to developments in foreign exchange rates than to exchange rate movements.

This brings me to the domestic economy and what the domestic situation looks like. The first bullet describes our view of the evolution of GDP from the perspective of what we expected in the forecast. The outcome for the first quarter of this year is more positive, in other words it surprised us on the positive side and GDP growth is higher than we expected. In Q1, GDP grew by 2.8%, but what is crucial, it must be said, is that the largest, or the main, driver of economic growth in Q1 was the contribution of net exports. This contribution was almost 2.5% of the overall 2.8%, which means that net exports generated by far the largest part of GDP growth, and to a smaller extent gross capital formation also contributed. I am stressing this on purpose, as this of course has implications for monetary policy in the sense that we are asking ourselves whether the growth that may surprise us, or is that surprising us, is inflationary or not. And as the overwhelming majority of this growth was driven by exports, or net exports, it shows, on the one hand, that the growth structure is not inflationary, it is not driven by domestic demand, and we already said six weeks ago that domestic demand was still weak, and moreover, if growth is driven by net exports, with a floating exchange rate this has to manifest itself in exchange rate appreciation. Again, that is the second channel that can keep inflation under control. So that is important for us, whether we are surprised on the inflation side. At this moment we do not see such a surprise.

Let us look at industrial production. In April, industrial production recorded very solid growth at 4.7%, confirming a continuing albeit partly slowing recovery. But the view that the Czech economy is starting to recover remains valid.

This is also indicated by employment data, with employment rising by 0.7% year on year, and the seasonally adjusted general unemployment rate decreased moderately and registered unemployment fell. These data indicate, and confirm, the onset of economic recovery.

Nominal wages: today the Bank Board discussed this item quite intensively, because if we look at whether growth is inflationary or not, and so far we have said that domestic demand is very weak and subdued, and if it is supposed to rise, we have to say from which sources it will be financed, and of course wage growth is the fundamental source of a potential recovery in domestic demand. Data for Q1 show that nominal wages increased by 2.1%. If we simply subtract from this the average inflation rate which was, I think, 1.6% or 1.7% in Q1, we see that real wages rose by just 0.4% in Q1. The Bank Board’s assessment today was that it does not regard this as an inflation pressure yet. If real wages are rising by just 0.4%, but productivity growth in this country is more than 2% or 2.5%, it is not inflationary wage growth at this juncture.

High growth in industrial producer prices, which was 6.2% in May, and even over 30% in the case of agricultural producer prices. This reflects, in our opinion, the evolution of global commodity prices. We have this bullet here on purpose, because if we see any inflation pressures at all, we believe that they currently stem only from commodity prices. Not from domestic demand, that still holds true.

Now I will look at how the Czech economy is developing by comparison with the forecast published six weeks ago. I already said that we were surprised on the positive side by GDP in Q1, with the forecast expecting 2.3% but GDP rising by 2.8%, but as I said we do not see this as an inflation pressure with regard to the structure of the growth, I stress that once again, because it was driven mainly by net exports, which will of course be reflected in the exchange rate of the koruna, and as I said, it confirms no domestic demand-pull pressures – private and government consumption is subdued. Inflation, yes, it also surprised us, jumping to 2% compared to 1.7% in the forecast, and again I said this was largely due to food prices, and here we express the hypothesis that the inflation pressures accumulated, as the increases in food prices do not occur every month, and we will see whether this will continue, whether these inflation pressures will materialise in domestic inflation or not. The average wage also surprised us, but as I said, even nominal growth of 2.1% does not mean, does not signal domestic demand-pull inflation pressures, because we have to look at the real wage, which rose by just 0.4%, and we have to look at labour productivity, which is rising at over 2%. The fall in unemployment confirms out current story that economic recovery is beginning. Now we only have to watch its intensity, of course, so that we take any further steps in time.

Now the penultimate slide, the assessment of risks. We also see the main risks to the current, still valid forecast, but these are risks that we assess now at this moment as we discussed them today at the Bank Board meeting. The first risk, of course, is higher current inflation. I already spoke about this, it is strongly connected with the fact that we are facing uncertainty as to further developments in food prices. If it is true that the sudden increase will halt, we think that it really doesn’t have to indicate any further pressures on inflation. Another upside risk to inflation was suggested today, a less anti-inflationary effect of the domestic economy. I think it’s perfectly relevant to mention this here, because if I said several times in this presentation that it was really said at the meeting today that we consider the stronger increase in GDP to be non-inflationary thanks to its structure, it is fair to ask “What if we are wrong?”. And of course we may be wrong, so we assess this as an upside risk in case we turned out to be wrong and domestic demand suddenly started to accelerate. But if it really started to accelerate, we would have to say what the sources would be. The last and largest upside risk to inflation we assessed, which was already mentioned six weeks ago, is still valid – an increase in VAT rates. I mention this here because since we prepared this as an alternative scenario six weeks ago the legislative process has progressed, it was already in the first reading, and to remain a consistent institution, we continue to include in our forecasts only things that really have been approved in the legislative process and are unambiguous, so that our forecast is based on the correct figures; therefore we prepared this as an alternative six weeks ago, and we discussed it again today, not from the point of view of what we can expect in terms of immediate effects on inflation, as such things are subject to our escape clauses, but what is important for us, we ask ourselves whether inflation expectations could increase and second-round effects occur, which is something to which we as a central bank should respond immediately. Today at the meeting it was said several times that we believe on the basis of the survey we conduct among households and financial analysts that inflation expectations are still well-anchored, although the draft act on changes to VAT has already taken a clearer shape than it had six weeks ago. This figure should be cited here: the long-term inflation expectations of the Czech public (we regard the three-year horizon as long-term in the case of inflation expectations) have long been anchored at 2.5%. This figure is above the CNB’s inflation target, but it is still within the tolerance band, which is ±1 percentage point.

These three upside risks were clearly mentioned at the Board meeting. On the other hand, two downside risks to inflation were discussed. First, a lower-than-forecasted outlook for foreign interest rates, which after all proved relevant to the today’s assessment of the situation, as the forecast includes the forecast for the 3M PRIBOR as expected by the market six or seven weeks ago, and you know that at that time there was relatively significant communication regarding the path of euro area interest rates. Since then a marked shift has occurred, with a less pronounced rise in interest rates being expected, which of course has a great influence on our forecast and our expectations, as the exchange rate channel, or rather the interest rate channel is very strong through its connection to the exchange rate channel and it is a thing we must monitor closely, so we will see to what extent this risk materialises. And another downside risk to inflation, I would say already a traditional one, was discussed at the Bank Board – it remains to be seen how the problems of some euro area countries and their solutions will develop. This is something we already discussed in January or February this year, when we drew up a “Debt crisis” alternative scenario within the first situation report, and we think that some arguments from this scenario remain valid, and the scenario, which is of course publicly available, clearly showed that there would be an impact on Czech monetary policy and Czech interest rates, and we assessed it as a downside risk. So these five basic risks were communicated and discussed today at the Bank Board meeting, and I am trying to communicate them like this, because that is in fact our task to get the message about these risks across from the Bank Board to the public.

I will end here, but before that I would like to draw your attention to one thing. The Bank Board decided that from next week it will launch a new tool. In order to show visually how the Bank Board assesses the current situation from the perspective of the forecast for inflation, interest rates, the exchange rate and GDP rather that just to give a verbal description, we will publish a Graph of Risks to the Inflation Projection (GRIP) together with the minutes of the meeting starting next Friday. Using GRIP, you will be able to read all these risks graphically including a numerical expression. We have already communicated on GRIP, it will show you not only the deviation from the inflation forecast, but also the deviation from interest rate expectations. One last sentence, we already communicated with analysts on GRIP, it is good to look not only at how the values are distributed, but also at the scale of the graph, whether we are talking about 1% or 2%, as the scale doesn’t always have to be unified and it is interesting to look at it also from the point of view of how high the risks are.