Minutes of the Bank Board Meeting on 29 March 2012

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 second situation report assessing the new information and its effect on the fulfilment of the inflation forecast contained in the first situation report. The risks to the forecast captured in the Graph of Risks to the Inflation Projection (GRIP) were broadly neutral, amid a slightly lower outlook for interest rates. A stronger exchange rate and declines in the outlooks for external growth and external market interest rates were having a slight downward effect by comparison with the baseline scenario of the forecast, but were being partially offset by higher domestic inflation. Headline inflation had risen as a result of the VAT increase and its pass-through to prices, especially food prices. In February, annual headline inflation had been 3.7 %, i.e. 0.3 percentage point higher than forecasted. Domestic economic activity was in line with the forecast, although the labour market data were slightly weaker. Outside the GRIP simulation, additional downside risks to inflation were associated with the currently stronger exchange rate compared to the average for Q1 and, from the perspective of monetary-policy relevant inflation, further potential government consolidation measures. A higher outlook for oil prices and short-term outlook for food prices were upside risks. A more detailed discussion of the risks to the inflation forecast can be found in the commentary on the GRIP.

In the discussion that followed the presentation of the situation report, the prevailing view was that the risks to the inflation forecast were balanced. Most of the board members agreed that the appropriate monetary policy response was to leave rates at the current level. It was said repeatedly that domestic demand-pull inflation pressures were not in evidence and that headline inflation had been affected by cost-push pressures in addition to the impact of the VAT increase on consumer prices, in particular food prices. However, it was said several times that the current headline inflation rate represented an upside risk to inflation, as did global commodity prices. It was also said that inflation expectations were still very well anchored at the one-year horizon and especially so at the three-year horizon, which is not affected by short-term shocks and is therefore more relevant.

The Board discussed in detail the interaction between the subdued domestic demand and external cost pressures. It was said that low growth in nominal unit labour costs confirmed the absence of demand pressures in the domestic economy. The opinion was expressed that the demand situation at home and abroad would probably prevent further growth in food and commodity prices. It was also said that monetary policy should not address short-term cost pressures. However, the view was also expressed that the external cost pressures would be long lasting and the weak domestic demand would not be able to absorb the inflation pressures stemming from rising prices of crude oil and agricultural commodities on world markets. On that point it was said that the higher oil prices would be absorbed by the appreciating koruna. The opinion was also expressed that there would be sustained spillover of rising unit labour costs from the developing economies to the advanced economies via exports.

The Board went on to discuss domestic economic activity. It was said several times that net exports were the only source of GDP growth. It was said that the economy of the Czech Republic’s main trading partner had growth potential, but there were significant risks in the event of a further escalation of the debt crisis. It was said several times that caution was prevailing in the domestic economy and that all the components of domestic demand were subdued. On this point it was said that the gross saving rate of households was rising. It was said that firms were continuing to accumulate cash and that this had probably already given rise to a fall in gross fixed capital formation. It was also said that fiscal consolidation would depress public and private consumption. The view was expressed that the repeated changes in indirect tax rates might be having an adverse effect on inflation expectations. The opinion was also expressed that meeting the inflation targets was important for maintaining the country’s credibility as a sovereign debtor.

It was said several times that despite the balanced risks to the forecast there were still significant uncertainties associated with the external situation. The opinion was expressed that these uncertainties were still increasing. It was said that there was great uncertainty surrounding the impacts and future use of unconventional measures by foreign monetary authorities on the one hand, and the continuation of fiscal restriction on the other. The opinion was expressed that these measures might lead to volatility in the exchange rates of world currencies and, in combination with market sentiment, might affect the exchange rate of the koruna. It was also said that the future path of the oil price could not be unambiguously estimated because, in addition to geographical changes in oil demand, there were major changes going on in oil extraction and substitution going on between different types of energy. It was also said that regulatory measures in various sectors of the economy were another element of uncertainty.

The Board also discussed the interaction between monetary policy and financial stability. The opinion was expressed that the current level of mortgage interest rates might represent a potential risk to future financial stability and that mortgages might be refinanced at higher interest rates after fixation periods end, which in turn might increase the default rate. However, it was said that it was unclear what the interest rate level for future fixations would be. It was also said that the credit default rate in this segment was low and households would cut their consumption if mortgage payments were to go up, so this was more an anti-inflationary risk.

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, Vladimír Tomšík, Kamil Janáček, Lubomír Lízal and Pavel Řežábek. Eva Zamrazilová voted for increasing rates by 0.25 percentage point.

Author of the minutes: Bořek Vašíček, Adviser to the Board