Minutes of the Bank Board Meeting on 3 May 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 third situation report containing the new macroeconomic forecast. The annual growth of the domestic economy – driven solely by net exports – had recorded a further noticeable slowdown in 2011 Q4. Headline inflation had increased significantly above the CNB’s target at the start of this year. Monetary-policy relevant inflation was in the upper half of the tolerance band around the inflation target. The VAT increase, food prices, administered prices and the gradual pass-through of the past exchange rate depreciation to prices were sources of inflation. By contrast, the slow growth of the domestic economy was dampening inflation.

According to the new forecast, headline inflation would be close to the current elevated values for the rest of 2012 and would fall below the target at the start of 2013. Monetary-policy relevant inflation would be in the upper half of the tolerance band this year and fall slightly below the target in 2013. Domestic economic activity would stagnate in 2012 owing to a marked slowdown in external demand, a downswing in domestic demand and continuing fiscal consolidation. In 2013 the economic was expected to grow by just under 2% in connection with a recovery in external demand. The nominal exchange rate was appreciating gradually over the forecast horizon. Consistent with the forecast was a decline in market interest rates in the remainder of this year followed by a slight rise in rates as from 2013 H2.

In connection with the planned budget measures, an alternative scenario incorporating the government’s planned measures leading to further fiscal consolidation in 2013 was prepared. These measures for the most part require changes to the legislation in force. In the alternative scenario, both VAT rates are increased, monetary-policy relevant inflation goes down and GDP slows, implying a lower interest rate path compared to the baseline scenario. The first-round impacts of the VAT rate increase lead to higher headline inflation than in the baseline scenario. The alternative scenario does not assume any significant second-round effects of the tax changes on prices. The exchange rate is almost the same as in the baseline scenario.

In the discussion that followed the presentation of the situation report, the prevailing opinion was that the appropriate monetary policy response was to leave monetary policy rates at the current level even though the forecast worked with a rate cut, because the risks to the inflation forecast were on the upside. The possibility of an increase in inflation expectations, a slightly weaker exchange rate of the koruna against the euro and higher commodity prices (especially oil prices) were identified as upside risks to inflation. The opinion was also expressed that the inflationary risks were more significant, for example because of underestimation of the pass-through of cost or tax shocks to prices.

Several of the board members expressed the view that a scenario close to the alternative scenario was highly likely to materialise and that this represented a downside risk to inflation owing to more subdued domestic demand. However, it was also noted that the effects of fiscal consolidation on the domestic economy were possibly being overestimated. Certain signals suggesting a less sizeable impact of fiscal consolidation – for example the expected recovery in household demand for construction work – were mentioned in this regard.

The Board focused on the potential rise in inflation expectations, which represents an upside risk to inflation. It was said several times that VAT rate changes made two years in a row could lead to a rise in inflation expectations. There was a consensus that the current situation was unique for the domestic economy in terms of the quantity of tax changes made in a relatively short period of time, and that there was no historical experience in this respect. The opinion was also expressed that cost-push inflation pressures could start to affect inflation expectations. Different opinions were expressed regarding the possibility of elevated inflation expectations passing through to wage growth. It was noted that thanks to the subdued domestic economy, inflation expectations would not feed through to wage growth. However, a number of the board members expressed the view that some pass-through might occur, for example thanks to the series of tax changes, which in the longer run would cause headline and monetary-policy relevant inflation to move apart.

The Board went on to discuss the inflation pressures in the domestic economy. It was said that economic growth was being driven solely by net exports and domestic demand pressures were contained. The effects of the growing supply-side inflation pressures and their potential spillover into prices were discussed in detail by the board members. The opinion was expressed that because of the long-running decline in nominal unit wage costs, the inflationary cost pressures would not necessarily spill over into the rest of the economy, since firms were in this way offsetting the high cost pressures stemming from commodity prices. However, several of the board members admitted the possibility of at least some spillover. The opinion was repeatedly expressed that the cost pressures had already accumulated quite considerably and that they might manifest themselves more significantly in inflation in the event of a recovery in 2013.

The Board then discussed the effect of commodity prices on inflation. The prevailing view was that the rise in commodity prices represented an upside risk to inflation. However, it was also said that the forecast took sufficient account of commodity price growth. Several of the board members identified possible reasons for higher commodity prices and for a greater effect of commodity prices on domestic inflation. Mention was made of the “financialisation” of commodities, i.e. the situation where commodities become a normal financial asset, which can lead to a rise in their prices. The effect of the easy monetary policy of several large central banks was also noted in the context of potential growth in commodity prices. It was also noted that materialisation of the risk of a weaker exchange rate of the koruna against the dollar would give rise to growth in the import prices of some commodities, especially oil, and thereby foster rising inflation.

A majority of the board members agreed that the external situation was still associated with a high degree of uncertainty and represented a risk on either side for the inflation forecast. The possibility of a continuation or escalation of the debt crisis in the euro area was noted. In this context, however, it was said several times that the level of uncertainty associated with the situation in Europe was not changing significantly. It was said repeatedly that there was no reason to react unless a major risk materialised.

The Board also considered whether there was any risk to financial stability from asset price bubbles in the domestic economy as a result of the lengthy period of low interest rates. The prevailing view was that there was no threat to financial stability in the current economic conditions. For example, as regards the property market situation it was said that the observed stagnation reflected the unwinding of earlier high growth in property prices and past strong growth in the construction industry and that a few minor indicators, such as the rising number of transactions in the property market, did not pose a threat to financial stability. With regard to the recently observed significant year-on-year rise in the number of new mortgages, it was noted that this largely involved the refinancing of mortgages taken out in 2007–2008 and was therefore not an indicator that households were taking on significantly more debt.

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

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