Minutes of the Bank Board Meeting on 3 November 2011

Present at the meeting: Miroslav Singer, Mojmír Hampl, Vladimír Tomšík, Kamil Janáček, Lubomír Lízal, Pavel Řežábek, Eva Zamrazilová.

The meeting opened with a presentation of the seventh situation report containing the new macroeconomic forecast. The growth of the Czech economy, which had previously been driven mainly by net exports, had slowed noticeably to 2.2% in 2011 Q2. Headline inflation had been fluctuating only slightly below the inflation target in 2011 Q3. Global commodity prices and food prices remained the main source of inflation, although the growth in food prices was slowing.

According to the baseline scenario of the November forecast, headline inflation would rise temporarily to just below 3% in 2012 owing to a VAT increase, but would fall back below the inflation target at the start of 2013. Monetary-policy relevant inflation would be slightly below the inflation target over the entire forecast horizon. Economic growth would slow in the remainder of 2011 and further in 2012, mainly in response to a contraction in external demand and owing to fiscal consolidation. Economic growth would then recover in 2013. Consistent with the forecast was a slight decline in market interest rates at the start of the forecast and flat rates until late 2012/early 2013. The baseline scenario of the forecast was expecting the koruna to appreciate gradually against the euro as a result of a low outlook for foreign interest rates.

Given the high degree of uncertainty surrounding the external economy going forward, an alternative scenario had been prepared. This had been motivated by concerns of inconsistency between the outlook for external economic activity and the outlook for foreign interest rates. The alternative scenario simulated developments abroad corresponding to the current market outlook for interest rates in the euro area. This scenario assumed a weaker exchange rate of the euro against the dollar and a further marked slowdown in economic growth in the euro area. The lower external demand then adversely affected domestic economic growth. Compared to the baseline scenario, the alternative scenario implied a substantially slower appreciation of the koruna. The weaker koruna exchange rate path in the alternative scenario was in turn associated with a higher interest rate level (by comparison with the baseline scenario), for which stability was assumed here. However, both headline inflation and monetary policy relevant inflation remained at roughly the same level as in the baseline scenario.

After the presentation of the situation report, the Board discussed its risks and related uncertainties. The Board agreed that the risks and uncertainties were currently extremely high and that the majority of them would come from abroad, owing mainly to the escalation of the debt crisis in the euro area. In this regard, doubts were repeatedly raised about the re-emergence of growth and inflation impulses abroad in 2013. The opinion was presented that the process of deleveraging the financial sector and sorting out the accumulated unsustainable debts would continue in Europe beyond 2012, that the investment climate would not improve, and that the impacts of the debt crisis and the related uncertainty would persist for a long time to come. It was also said that the stabilisation potential of economic policies in many countries was much lower than in the past. Against this it was said that although the euro area as a whole would very probably see a strong slowdown in economic growth, the euro area was structurally very heterogeneous and economic growth in the Czech Republic’s biggest trading partners was much higher than in the rest of the euro area.

Given the adverse situation in the euro area, the Board agreed that the alternative scenario provided a more realistic picture of the future than the baseline scenario. Besides a more consistent combination of outlooks for external variables and a lower rate of growth of the external economy, the main argument made here was the low probability of renewal of the relatively sharp appreciation trend of the koruna. Some of the board members also pointed to the marked depreciation of the euro against the dollar in the alternative forecast scenario. In their opinion, a weaker euro-dollar rate would foster higher koruna prices of commodities and could also affect the terms of trade, because Czech exports go mainly to the euro area while imports are affected mainly by dollar prices.

In their assessment of the domestic economic situation, the board members agreed that domestic demand was generally anti-inflationary and that the only factor fostering higher inflation was the projected evolution of wages relative to whole-economy labour productivity. It was said several times that the forecast for wage growth in both the business and non-business sectors was too high in light of the low future GDP growth. In connection with this lower domestic GDP growth, some of the board members emphasised the deterioration of most leading and confidence indicators. The decrease in growth of new industrial orders was discussed in particular; besides lower growth in orders from abroad, the fall in domestic orders was accelerating. Survey expectations of business managers, according to which the effect of low demand as a barrier to growth in industry was strengthening, were also mentioned. With regard to the structure of domestic demand, in addition to the slow growth in household demand and businesses’ reluctance to invest, the Board discussed the projected path of public consumption. It was said repeatedly in this regard that to sustain the public finance deficit at the budgeted level it would be necessary to make further spending cuts and tax changes. Fiscal policy could therefore be expected to be procyclical.

At the close of the meeting the Board decided by a majority vote to leave the two-week repo rate unchanged at 0.75%. Six members voted in favour of this decision: Miroslav Singer, Mojmír Hampl, Kamil Janáček, Lubomír Lízal, Pavel Řežábek and Eva Zamrazilová. One member voted for reducing rates by 0.25 percentage point: Vladimír Tomšík.

Author of the minutes: Michal Hlaváček, Adviser to the Board