Minutes of the Bank Board Meeting on 1 November 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 seventh situation report and the new macroeconomic forecast covering the horizon until the end of 2014. Headline inflation was currently above the inflation target, while monetary-policy relevant inflation was at the target level. Tax changes and gradually subsiding growth in import prices and food prices were the sources of the observed inflation. By contrast, domestic demand was curbing inflation. The Czech economy would contract by 0.9 % this year owing to a marked slowdown in external demand and generally subdued domestic demand.

According to the new forecast, headline inflation would be slightly above the target next year owing to tax changes, and would fall below the target in 2014. Monetary-policy relevant inflation would be in the lower half of the tolerance band over the whole forecast horizon. Compared to the previous forecast, the October forecast for inflation in 2013 and 2014 was not significantly different. Next year, when the forecast was expecting a gradual external demand recovery and restrictive impacts of domestic fiscal consolidation to act in opposite directions, GDP would rise by 0.2 %, i.e. by 0.6 percentage point less than expected in the previous forecast. In 2014, GDP growth would pick up to almost 2 %, i.e. by 0.5 percentage point less than in the previous forecast. The exchange rate of the koruna against the euro was broadly stable over the forecast horizon. Consistent with the forecast was a decline in market interest rates, followed by a rise in rates in 2014.

In the discussion that followed the presentation of the situation report, the prevailing opinion was that the risks to the new inflation forecast were balanced. Most of the board members agreed that the appropriate monetary policy response was to lower rates to technical zero and keep them at this level over a longer horizon until inflation pressures increased significantly. However, the opinion was also expressed that a further easing of the monetary conditions would be appropriate only if there was a risk of inflation deviating below the tolerance band, and that given the large uncertainty the more appropriate response would be to wait for new GDP and inflation data. It was said repeatedly that inflation would be in the lower part of the tolerance band for the foreseeable future and that a decline in rates was consistent with this outlook.

The Board discussed the structure of inflation and future scenarios for inflation. There was a consensus that the contraction of the economy meant that demand-pull inflation pressures were not apparent and that cost pressures were the primary source of current and expected inflation. In this regard, it was commented that the fall in import prices, agricultural producer prices and food prices might be less pronounced than predicted by the forecast. Most of the board members felt that low growth at home and abroad would lead to a further decline in inflation.

The Board then discussed economic growth. It was said repeatedly that the domestic economy was very subdued as a result of a combination of domestic and external demand factors. It was said that the economic recovery would be very weak over the forecast horizon. The opinion was repeatedly expressed that fiscal consolidation was having a strongly restrictive effect on domestic demand. However, the opinion was also expressed that private consumption was being negatively affected by the current level of consumer prices of essential commodities. It was said that net exports would probably be the main source of economic recovery.

The Board discussed household consumption and savings in detail. There was a consensus that the subdued domestic economy was characterised by low consumption. It was said that consumption growth was currently at its lowest level in two decades. It was also said that a temporary rise in the saving rate might have caused domestic demand to decline and that if the saving rate were to stay at elevated levels it could hinder the economic recovery. The opinion was also expressed that consumption follows a cyclical pattern and that households had invested in durable goods before the crisis and were now saving, but the deferred consumption would gradually be realised.

It was said several times in the discussion that the future was subject to significant domestic and external uncertainties. The board members agreed that the assumptions regarding tax settings represented an uncertainty for the headline inflation forecast and, via their impact on consumption, also for the monetary-policy relevant inflation forecast and the composition of GDP. The opinion was also expressed that a protracted decline in economic performance could itself contribute to a deterioration in the financial markets’ assessment of the Czech Republic. The exchange rate was identified as another source of uncertainty. The opinion was expressed that while the current account balance might support a strengthening of the koruna, an interruption of the convergence process might cause it to weaken. The impact of relatively rapid M2 growth was also included among the risks to the forecast. It was also mentioned that the intensity of transmission was also a risk, as financial institutions had partially tightened their credit conditions despite the recent easing of monetary policy. It was said repeatedly that the assumptions regarding developments abroad, especially in Europe, also represented a risk to the forecast. It was very hard to predict the behaviour of economic agents at a time when fiscal policy in many countries had reached the financial markets’ tolerance limit. The opinion was expressed that in light of this limit the recovery in external demand could be slower than assumed by the forecast.

At the close of the meeting, after assessing the technical, legal and other aspects of the proposed monetary policy decision, the Board decided to lower the CNB two-week repo rate by 0.20 percentage point to 0.05 %. At the same time it decided to lower the Lombard rate to 0.25 % and the discount rate to 0.05%. Five members voted in favour of this decision: Miroslav Singer, Mojmír Hampl, Vladimír Tomšík, Kamil Janáček and Lubomír Lízal. Two members voted for leaving interest rates unchanged: Pavel Řežábek and Eva Zamrazilová.

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