Transcript of the introductory statement from the press conference - 3 November 2011
GOVERNOR
As you know, we decided to leave the limit repo rate unchanged. Six Bank Board members voted for this decision, and one member voted for lowering rates by 0.25 percentage point.
As regards the reasons for the decision, monetary-policy relevant inflation is slightly below the inflation target over the entire forecast horizon. Even headline inflation, which, as you know, is subject to an escape clause, and which, I assume you also know, will rise because of a VAT increase in 2012, will stay within the interval, i.e. it will remain below 3% and will, in our view, fall below the target in our opinion in early 2013. Consistent with the forecast is a slight decline in market interest rates and flat rates until late 2012/early 2013. However, while for monetary-policy relevant inflation this is true for what we have in both the forecast and the alternative scenario, which I’ll tell you more about later, we assessed the risks to the forecast as being skewed towards interest rate stability in the spirit of the alternative scenario, which has the working title “euro area stagnation”. I’ll show you this scenario as well today. Sometimes we are really glad that we had an alternative scenario drawn up.
As for the summary of the baseline scenario, it assumes that inflation pressures are currently not significant. Commodity prices and food prices are still the main sources of inflation. Headline inflation, as I said, will rise on account of VAT and then return below the target. I already spoke about interest rates as well, so let me talk about growth. The baseline scenario expects a slowdown in growth in the rest of this year and a further slowdown to 1.2% next year in connection with what is more or less already happening in the euro area. Stronger growth is not expected to occur until a year later. By contrast, the nominal exchange rate is appreciating at the forecast horizon from 2012 owing to numerous factors. As I already said, consistent with this forecast is a slight decline in market interest rates followed by flat rates.
That brings me to the external environment. Consumer prices in the external environment are showing no pressures, and where they are, or the increases we are expecting – just to remind you, we take these principally from Consensus Forecasts – are decreasing. Similarly, expected producer prices are falling slightly as from next year, while GDP for next year has been revised relatively significantly downwards in the euro area. The same goes for the EURIBOR. It, moreover, has been revised downwards relatively significantly for 2013 as well. As for commodity prices, Consensus Forecasts again expects a decrease. The exchange rate is moving in the direction which can be expected and which also reflects the assumptions or consensus of the analysts.
This brings me to the baseline scenario. This is what I spoke about. In the baseline, headline inflation moves slightly below the boundary of the tolerance band. I emphasise again that even if it were to cross it, this is not our target. In other words, we apply an escape clause to the effect that is increasing it – the VAT rise. However, inflation probably should not exceed 3% anyway. Conversely, monetary-policy relevant inflation remains below the target in the lower half of the tolerance band over the entire forecast horizon. Gross domestic product: we already saw the figures. It is falling next year and rising in 2013. To allow this course of things to happen at all, interest rates must decline slightly and start to rise again towards the current levels only at the end of next year. All this is conditional on an exchange rate that is appreciating very quickly.
If we compare with the previous forecast, you can see that consumer prices underwent a downward correction, the same as for GDP in all periods. For GDP next year, the baseline expects somewhere above 1% and a relative acceleration the year after next. And what I said about interest rates can be seen here for these rates. The koruna initially depreciates but then remains the same over the next two years compared to the previous forecast. In other words, fundamentally we still see the same exchange rate conditions, with no dramatic change in outlook.
However, we prepared an alternative scenario – or asked for it to be prepared, to avoid giving the impression that the Bank Board prepared it itself. We asked our people to draw up an alternative scenario assuming a more marked stagnation in the euro area. As I said, or I would say, I dare say, the decision of most or all of the Bank Board members was significantly influenced by this scenario. The motivation is the feeling that the outlook for foreign economic activity and the outlook for foreign economic rates – as you know, we use both these consensus outlooks as forecast assumptions – were not mutually consistent. In other words, it seemed to us that rates are well below the level consistent with what is expected in economic activity. So, we used the model of foreign economies to simulate the foreign economic developments that would be consistent with the market outlook for euro interest rates. In other words, we took the variable that is actually traded and we asked our people to model what the developments would look like consistently with the model of the European economy if those who trade in interest rates are right. In this scenario, GDP growth in the euro area slows considerably to almost zero. This transmits to us and negatively affects our GDP. In such case, of course, because demand for our output is lower, the koruna appreciates much more slowly, and the weaker exchange rate is connected with higher interest rates compared to the baseline scenario. Inflation is broadly the same as in the baseline scenario, so the first sentence on the slide summarising our reasons for doing what we did holds true for both scenarios; the inflation pressures from the domestic economy are currently not significant, and we expect nothing dramatic going forward.
If we look at what this means... I already talked about inflation. The picture is basically the same as in the baseline scenario. However, for GDP this means a significant change. Of course, I’m unable to say now what percentage of each scenario we each expect to materialise, so I’m also unable to answer what GDP level we expect. The forecast exists, it applies, but in addition to it something has been elaborated on the basis of the events of the past few weeks, which most of us are inclining towards. It must be said that it was derived using, let’s say, lighter modelling equipment, a different methodological approach, but we arrived at the conclusion that the options are somewhere in between basically for each of us. And this “somewhere in between” in turn influenced the interest rate decision.
And if you look at this “somewhere in between” for rates, it implies basically no change. At least in the near future this scenario assumes no change. And even later on, the area between the dashed line and the full line is basically a slight change or stability.
As regards the exchange rate, as I said, much slower appreciation from the current levels is expected and the deviations are not very dramatic over the entire forecast horizon.
We have also prepared for you a comparison of all the scenarios at once. So, this shows three columns instead of the usual two. The first is the previous forecast, the second is the new forecast, and the third is the alternative scenario. As you can see, there is virtually no difference there for consumer prices. The difference in GDP is rather dramatic, especially next year, which would be affected most of all by a further fall in foreign trade activity. For interest rates, something very close would be assumed for next year, something very close this year, something very close to the current reality next year, but not close to the baseline scenario, and then in 2013 the forecast and the alternative scenario are both similar. I already commented on the exchange rate. After all, it is easier to see from the charts.
What could help the economy to withstand and get over this situation in qualitative terms... I already spoke about this. We know that our economy is very dependent on international activity, especially in industry. So, on the other hand, the factors we regard as robust, or at least I certainly regard as robust, are the high resilience of Czech corporations, which are in good condition and have proved – not only in this crisis – their resilience and ability to repay loans. The sector has seen no major shocks, or no shocks equivalent to the dramatic decline in GDP a few years ago. Just like back then, the crisis will probably occur via the foreign trade channel in our country, because like during the last potential downturn we expect no problems in the financial sector. On the contrary, it will be a source that will perhaps help us – or that will help us, to avoid sounding tentative.
Let me now move on to the last slide, which shows the main risks. Wage growth, of course, and a substantial deterioration in expected foreign economic growth, which would of course also lead to a decline in the outlook for world commodity prices and a decline in interest rates, remain among the downside risks to inflation. So those are the downside risks to inflation. On the upside, if the stagnation scenario were to materialise, it would of course involve a fundamentally weaker exchange rate. The weaker exchange rate – and this is a risk that is not included in the alternative scenario – could also partly weaken due to market sentiment.
Let me just draw your attention to the fact that the risks are now dramatically higher than usual in either direction. In other words, the fans of the scenarios are broad. In any case, price stability remains the fundamental guiding principle for us and in this sense we are also prepared. I can imagine movements in either direction, in both directions, if they are needed to maintain price stability.