Minutes of the Bank Board Meeting on 2 August 2012

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

The meeting opened with a presentation of the fifth situation report and the new macroeconomic forecast covering the horizon until the end of 2014. Headline inflation was currently well above the inflation target, while monetary-policy relevant inflation was close to the target. Tax changes, commodity prices and depreciation of the koruna were the sources of the observed inflation. By contrast, domestic demand was dampening inflation. According to the new forecast, GDP would decline by 0.9% this year. Only net exports were showing a positive contribution to growth. Wage growth adjusted for one-off effects was moderate. The forecast expected economic growth in the euro area to slow sharply this year. Inflationary pressures from import prices would weaken.

According to the August forecast, headline inflation would converge to the inflation target by the end of 2012 and would fluctuate slightly above the target in 2013 owing to tax changes. Monetary-policy relevant inflation would decline below the target at the end of this year and would remain below it until the end of the forecast horizon. The two rates of inflation would converge in early 2014. Compared to the previous forecast, the August forecast for headline inflation was lower for 2012 but higher in 2013 owing to tax rates. The outlooks for administered prices and net inflation were lower. The forecasts for all components of net inflation except food had been lowered. By contrast, the forecast for food price inflation had been increased. The anti-inflationary effect of the domestic economy would gradually fade, but domestic inflationary pressures would not emerge. For 2013, the forecast was predicting a gradual recovery in growth in the euro area. The domestic economy would also enter a phase of very modest recovery, although this would be slowed by expected fiscal restriction. For 2014, the forecast was expecting the domestic economy to grow by 2.5%, supported by growth in net exports and a recovery in household consumption. Foreign rates would stay well below the levels of the previous forecast over the forecast horizon. The nominal exchange rate would gradually appreciate from its current weakened values over the forecast horizon. Consistent with the forecast was a decline in market interest rates in the next few quarters, followed by a rise in rates in 2014.

In the discussion that followed the presentation of the situation report, the Board agreed that the new forecast was based on the alternative scenario presented together with the May forecast. In line with this scenario, the August forecast took into account the VAT increase, the downturn in household consumption and the subsequent slower GDP growth. This effect was amplified by a deterioration in the euro area growth outlook, reflected in a reduced market outlook for foreign rates. The Board stated that the August forecast had risks on both sides. The upside risks to inflation included uncertainty connected with the future path of commodity and food prices and a possible further change to VAT. The downside risks mentioned in the discussion included a possible delay of the recovery in the euro area and the introduction of additional fiscal consolidation measures. As information that would be available in the coming months might clarify the extent of these risks, a majority of the board members recommended a wait-and-see approach. However, it was also said that a timely interest rate cut was the appropriate monetary policy response.

The Board discussed the causes of the worse growth outlook for the Czech economy. The opinion was expressed that the reduced ratio between reinvestment and dividends observed in the income balance in the case of profits of foreign-controlled companies might be one of the causes of the muted investment activity and might also be contributing to slower potential output growth. It was said repeatedly that relatively pessimistic private sector expectations were a major factor, in addition to the negative growth outlook for the euro area and the impacts of fiscal consolidation, and that this pessimism was not necessarily in line with Czech economic fundamentals. In this context, it was said that the expectations of households and firms evidently did not fully reflect the good condition of the Czech financial sector, the available reserves of the private sector (as implied, for example, by the high deposit-to-loan ratio) or the fiscal position, which was different from that in euro area countries hit by the debt crisis. It was also said that private sector expectations were being shaped predominantly by negative information about the situation in the euro area. The opinion was expressed that the observed decline in GDP was relatively modest and temporary and should not lead to any further deterioration of expectations.

In this context, the Board discussed the expected sources of growth in 2013 and 2014. It was said that besides net exports, investment was also being driven to a large extent by external demand. It was also said that the forecast was assuming that the Czech economy could also rely on autonomous sources of growth in the form of realisation of deferred household consumption and renewal of the inventory cycle. It was said several times that this assumption suggested the possibility of the growth rate of the Czech economy decoupling from that of the euro area and hence the possibility of gradual renewal of the real convergence process. However, the opinion was also expressed that household consumption might be affected by the pension reform, which might conversely increase the saving rate.

The Board discussed the effect of external factors on the new forecast. It was said repeatedly that the sharp reduction of the foreign interest rate path over the entire forecast horizon was not too consistent with the expectations of a gradual renewal of growth in the euro area in 2013 and that this lack of consistency introduced additional uncertainty into the decision-making. In this context, the opinion was also expressed that the growth outlook in the euro area would be affected by the willingness to make structural changes.

The Board went on to discuss the risks to the forecast connected with cost factors and the exchange rate. It was said several times that prices of oil, agricultural commodities and foods might grow faster than assumed by the forecast. The opinion was also expressed that growth in regulated prices and the potential second-round effect of the VAT increase next year might be higher than forecasted. In this context, it was said that the assumed oil price path was different from the assumed gas price path and that this might also represent a risk to the forecast. On the other hand, it was said that increasing extraction of shale gas might explain the different price path. It was said several times that the exchange rate represented both an upside and a downside risk to the forecast. On the one hand, it was said that the exchange rate of the koruna was currently being determined by external factors, in particular risk aversion in the European region. On the other hand, it was argued that the koruna exchange rate is determined primarily by foreign trade, and that was sending out favourable signals.

At the close of the meeting the Board decided by a majority vote to leave the two-week repo rate unchanged at 0.5%. Four members voted in favour of this decision: Mojmír Hampl, Kamil Janáček, Pavel Řežábek and Eva Zamrazilová. Two members voted for reducing rates by 0.25 percentage point: Vladimír Tomšík and Lubomír Lízal.

Author of the minutes: Kateřina Šmídková, Adviser to the Board