Transcript of the introductory statement from the press conference - 2 August 2012

VICE-GOVERNOR

Let me recapitulate the monetary decision adopted, even though we already published it at 1 p.m. The Bank Board of the Czech National Bank decided to leave the basic two-week repo rate at the current level of 0.50%. Four board members voted for this decision, that is, for leaving the repo rate unchanged. On the other hand, there were two members who voted for lowering the basic 2W repo rate.

In a nutshell, in three main points, the three main reasons for today’s decision are as follows. We are saying that according to the new forecast, which will be published in a few seconds, headline inflation will be slightly above the CNB’s inflation target at the monetary policy horizon, owing mainly – and I emphasise this – to tax changes. By contrast, monetary-policy relevant inflation will be in the lower half of our tolerance band around the inflation target. An important thing which must be mentioned every time is the assumption about what level of interest rates is consistent with the newly published forecast. Here let me read it word for word: consistent with the new forecast is a decline in market interest rates in the next few quarters, followed by a rise in rates in 2014. I think I have the mandate to put an emphasis on the phrase “few quarters”. As for the third key factor – why rates were left unchanged today, and not lowered, although you can see the sentence on interest rates just above this – it is important to say that the Board viewed the risks as being balanced overall. A lowering did not follow because the Board opted for the wait-and-see principle. I will get back to this – to the main reason – in a moment.

Let me sum up the baseline scenario of the forecast. Before I get to the individual points, I think the title is also very important, because you know that when we last presented a new forecast three months ago, we said publicly that we had a baseline scenario, but we also had an alternative one, which we published three months ago. Today, we are saying transparently that the situation is such that there was a general consensus on preparing just one – baseline – scenario, and we made our decision on the basis of that.

Let me take you through the main points of this scenario. It says that the main sources of observed inflation, about which I said a moment ago that headline inflation may be slightly above the target at the monetary transmission horizon, are tax changes – this is important to say, i.e. it is not demand-pull inflation – tax changes, commodity prices and the exchange rate depreciation observed to date. By contrast, we still hold the view that we presented before, that the domestic economy will dampen inflation. This means we see no domestic demand-pull inflation pressures. I will now repeat what I already said – headline inflation is expected to fall to the CNB’s target late this year or early next year. Monetary-policy relevant inflation will even fall below the target. To make our forecast complete – I already talked about inflation, I talked about the interest rate assumption, I will move on to the exchange rate assumption in a while – it is important to say what the forecast covers. It covers the evolution of the economy, the evolution of expected GDP. There is a relatively large change in our expectations and our forecast. Specifically, we expect the Czech economy to record a decline of up to 0.9% this year, and we expect a very, very moderate recovery of +0.8% next year. A stronger recovery – of course the question is what “stronger” means – cannot be expected until 2014. We predict the figure to be 2.5%. As for the assumption regarding the nominal exchange rate, we are saying that the nominal exchange rate against the euro will appreciate gradually. I will return to this in a moment when I have the usual exchange rate fan chart. Then it will be good to say a few things about that. I already said the sentence on interest rates, so let me move on.

What has changed so much since three months ago, when we published the previous forecast with the alternative scenario? Here I will more or less skip the first two columns, i.e. the issue of price developments in the euro area, because there are only minimal changes in consumer prices and producer prices. But the radical change we see here is a relatively sizeable change in the final column – the three-month EURIBOR – and also economic developments in the euro area, which also reflect that. These are communicating vessels. I will elaborate on the three-month EURIBOR for a while. If you look more specifically, these are market outlooks. This is not something the CNB forecasts, it is a fact we take from the market. The market outlook for the three-month EURIBOR declined from 0.8% to 0.5% for 2013 and to 0.6% for 2014. For us, this is a big change in the forecast. That the three-month EURIBOR is very low is demonstrated by the fact the market outlooks were not this low even when the crisis peaked after the fall of Lehman Brothers. I would say this is one of the biggest changes in our current – in the inputs of – our current forecast. This is consistent with a rather large change in expected GDP growth in the euro area. We can see that it is currently still improving from 0.5% to 0.7% this year – GDP growth in the effective euro area – but for 2013 it is exactly the opposite, and we can see a significant cooling from 1.6% to 1.2%. This is a significant change in an input of our forecast, and we of course subsequently had to reflect this in our forecast, as we are a small open economy.

Turning to two other important inputs of our forecast, one of them is the Brent oil price. Again we take this from the markets, from the Consensus Forecasts outlooks. You can see that we can see a decrease in the Brent oil price has been recorded since the previous forecast. On the other hand, we do not attach any sizeable effect on our forecast to this, as this decrease is offset by a change in the dollar-euro exchange rate. In other words, the impact on this forecast is not so significant, because the drop in the Brent oil price is offset by the exchange rate of the dollar against the euro. So I would not regard this as a radical change.

And now for the crucial thing – the CNB’s headline inflation forecast, on the basis of which we of course derive our monetary policy actions. I have already mentioned this – yes, we are currently above the inflation target, but we expect to return to the target of 2% relatively quickly, and at the transmission horizon we will be only slightly above the centre of the corridor, above the target of 2%. But it is important to say why, and I have mentioned this already. We expect – at the moment we see tax changes, commodity prices and past exchange rate depreciation. That is why we are now above 3%. And going forward we again expect a rise at the monetary transmission horizon, owing mainly to the already announced tax changes. I will return to this in the comparison with monetary-policy relevant inflation.

You can see that monetary-policy relevant inflation, which is adjusted for changes in indirect taxes, is below the centre of the inflation target, below the centre of the corridor around the inflation target of 2%, over almost the entire forecast horizon, including the most relevant part, the horizon of monetary policy and most effective transmission.

To illustrate the difference between headline and monetary-policy relevant inflation, I will show you this slide, where you can clearly see where we are today, where headline inflation is, the black line, and where monetary-policy relevant inflation is, and how we expect these two indicators to develop further. You can see that the difference between the two indicators is sometimes more than a whole percentage point. That is by no means little, because it is exactly one-half of our inflation target, as the target is 2%. This is due mainly to indirect tax changes, which of course we treat as an exemption from our inflation targeting.

I think I have more or less made that clear, so let us move on to other parameters, namely what we expect for GDP. I mentioned the key figures. Yes, we have lowered the GDP forecast for this year. When we said previously that GDP growth would be more or less around zero, it was a sort of negative zero. Today we are significantly reducing the forecast to -0.9% this year and to very weak growth of +0.8% next year. However, it is good to look at the individual components. We continue to see one of the most significant, or the most significant, decline for private consumption. Looking at the figures, this year we expect household consumption to drop by 1.5%, one of the largest declines in private consumption recorded in the history of the Czech Republic. Moreover, this GDP component – private consumption – has the largest share in GDP. That means it has the largest weight.

The news, or signals, from gross capital formation are not too good, either. I’ll say right away that it is not easy for us to distinguish in the model between investment and inventories. That’s why we use gross capital formation in the forecast. Unfortunately, I must say here that we expect gross capital formation to decline by almost 9% this year and we expect no major increase in gross capital formation next year, as the forecast expects growth of only 0.6%. The big question is what growth can be expected in 2014. The forecast is for 0.7%. This means that even this component of GDP will rise very, very moderately.

The good news may be that although export growth will no longer be as high as in the past, we still expect it to exceed imports. Specifically, we expect exports to grow by 7% and imports by only 4.7% this year. In other words, GDP growth is still due solely to external developments, the contribution of net exports. This is the only component contributing positively to GDP growth.

Don’t worry, I didn’t forget government consumption and fiscal developments. As I said, three months ago we presented a baseline and an alternative scenario. I am now saying transparently that in those three months it has turned out that we are getting closer to the previous alternative scenario. In other words, in the new forecast the Czech National Bank has switched to the alternative scenario and government consumption cannot be expected to contribute positively to GDP growth this year or the next. This is of course due to consolidation of public finances. We do not assess this. We take it as a fact.

The forecast for interest rates is consistent with our forecast for inflation and other variables. What is important – what I’d like to emphasise – is that our forecast, as you can see, expects a declining three-month PRIBOR. We believe it is good that this downward trend, or the market outlooks for interest rates are in line with our previously communicated decline in rates. So you can see that there is a downward trend and, importantly, we are saying that market rates will record declines over the next few quarters and we expect then to increase again in 2014.

How can I explain this exactly? I’d like to offer four main factors, which were also discussed at the board meeting today. The first thing, which I have already mentioned, is in line with developments abroad, where market interest rates – specifically the three-month EURIBOR – are at a historical low. That is something we must reflect in our interest rate forecast. The second thing is that the domestic three-month PRIBOR must reflect developments on the domestic market, and it has been said here that domestic economic activity is very, very subdued. This gives rise to the third factor underlying the forecast: if you have subdued economic growth, you cannot expect a balanced acceleration in wage growth. We expect wages to increase very moderately, and this of course also underlies the low interest rates. The fourth factor I’d like to mention here – and I have already mentioned it in connection with GDP – is the government’s continued restrictive fiscal policy. These are the main four factors underlying the decline in market interest rates that we expect in the Czech Republic.

The exchange rate forecast. For the exchange rate forecast – which is consistent with the published forecast for inflation and all the other variables – it still applies that we expect a continued appreciation trend in the medium or long term. Of course, it is appropriate to ask how strong the trend will be. And you can see that for the first quarter of the forecast we expect moderate stability or possibly a slight depreciation. I’d like to repeat that the way the forecast for the exchange rate is currently configured – and this was mentioned at the board meeting – we insist that the basic factors underlying our forecast for the exchange rate still apply. Those factors are the balance of payments, foreign trade and the catching-up process, i.e. the convergence of the Czech economy. Why do we have moderate stability or a very slight appreciation for the near future? Because at the moment – if we look at how the convergence of the Czech economy is proceeding – this factor is very, very weak. The convergence is not proceeding at the same pace as before, in the pre-crisis period. GDP in the Czech economy is not increasing as much as before. That means that this factor is no longer exerting appreciation pressure on the exchange rate of the koruna. That is the first fact. As for foreign trade, we still maintain – as I’ve said – that this is the only component that is contributing to GDP growth. Nevertheless, the rates are no longer as high as in the past, and the fact that the koruna exchange rate will start to appreciate again in the medium and long term stems from the expectation that foreign trade will be the main driver of economic growth in the future, in the coming year, year and a half, two years. And renewed appreciation of the exchange rate is consistent with this. Therefore, at the moment, the new forecast for the exchange rate is still based on the old factors underlying the exchange rate theory. Let me repeat them: the balance of payments, foreign trade and convergence. Of course, you can add a fourth factor, which I have so far deliberately skipped, namely the risk factor. We still believe that the Czech economy is sound and risk-free. The risk premium may be lower than in other countries. This can be left for the discussion. But I am saying that the appreciation of the exchange rate will not be as pronounced as before because of foreign trade, which is no longer increasing as much as in the past, and because of a temporary weakening of the catching-up process.

A comparison with the previous forecast. I think the biggest differences can be seen in the first column, that is, in consumer prices, where we can see a rise in inflation in both 2013 and 2014. But we must say here that this is due to VAT changes. Specifically, previously we did not count on VAT not being unified. By contrast, we are now saying it will not be unified and that it will rise. So, the new forecast already takes into account the VAT rise of 1 percentage point and no unification of VAT rates. Furthermore, it takes into account the changes to taxes on cigarettes. And, importantly, the increase in the forecast for inflation also currently reflects commodity prices. You know that commodity prices have increased. And, of course, it reflects the currently weaker exchange rate than we expected three months ago.

Another major change is in GDP, which is the second section, where we can clearly see that we previously said zero and now there is a significant deterioration to -0.9. I have mentioned the underlying factors. Both the foreign economy and the domestic economy are worsening. There is a significant change in the PRIBOR, from 1% in 2013 to 0.3%, but this should be no surprise to the market, because I have said that we are switching to the alternative published three months ago, and the alternative indicated lower interest rates.

I have discussed the exchange rate of the koruna, so there is no need to repeat it.

Ladies and gentlemen, the last slide: the risks which were discussed at the board meeting today and why the Board decided to postpone any movements in interest rates. Yes, the anti-inflationary risks to the current forecast were also discussed. We identified anti-inflationary risks there as well. The biggest anti-inflationary risk discussed today was: what if additional fiscal measures are taken for 2014? The forecast published today only includes the fiscal measures so far announced and prepared in the legislative process. Three months ago these were only proposals. During those three months they have been going through the standard legislative process. They have been approved by the government and are currently in the Parliament. So, these measures have been incorporated into the forecast as additional measures for 2014. Of course, this has implications for inflation, on the anti-inflationary risk side. On the other hand, it was mentioned that there are some inflationary risks. Specifically, the discussion focused on possible higher world prices of energy and agricultural commodities.

Overall, however, the Board said that it regarded these two risks to the currently published forecast as being balanced. However, the Board decided not to take the step to lower interest rates even though that would be in line with the forecast. The reason for this is that a majority of the Board said let’s take a wait-and-see approach, because new information may become available confirming our expectations, our forecast, and then we can act.

Ladies and gentlemen, I think this covered not only the decision, but also the background of the decision in a nutshell, and now I am ready to answer your questions. Thank you for listening.