Minutes of the Bank Board Meeting on 27 June 2013

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 fourth situation report assessing the new information and its effect on the fulfilment of the inflation forecast contained in the third situation report. The new situation report assessed the overall risks to the forecast as being anti-inflationary and tilted to a need for easier monetary conditions. Headline inflation had gone down by 0.4 percentage point to 1.3% in May and was thus 0.3 percentage point lower than forecasted. The deviation had been due to lower adjusted inflation excluding fuels (owing to a larger reduction in prices of telecommunication services), as yet very weak pass-through of changes in excise duty on cigarettes, a sharper decline in fuel prices and also slightly lower growth in administered prices. By contrast, food price inflation had been higher than forecasted. According to the situation report, the year-on-year decline in real GDP had deepened to -2.2% in Q1, representing a decrease of 0.7 percentage point more than had been forecasted. This deviation had been due to lower gross capital formation as a result of a deeper decline in inventories. Household consumption, conversely, had been less unfavourable than forecasted. The contribution of net exports to GDP growth had been slightly negative, as expected in the forecast, while the contribution of government consumption had been positive. The sharper economic contraction was offset by a more favourable demand structure, aided by a revision of the data for 2012. Wage growth had had a neutral effect in Q1 and had been largely due to the one-off effects of tax optimisation. The exchange rate of the koruna was only slightly weaker than forecasted. A more detailed discussion of the risks to the inflation forecast can be found in the commentary on the Graph of Risks to the Inflation Projection (GRIP).

In the discussion that followed the presentation of the situation report, it was said repeatedly that the data that had been published since the last situation report represented an accumulation of anti-inflationary risks to the forecast and that the differences in inflation and GDP compared to the forecast were significant. It was said that risks towards a need for easier monetary conditions had already been identified when the forecast was being discussed six weeks earlier and that the new data were strengthening this need. However, it was also said that the new data did not have significant impacts on the assessment of the risks to the inflation forecast. It was said that although anti-inflationary risks were accumulating, the domestic economy was unlikely to be heading into deflation when rates were at technical zero. There was a consensus that the appropriate monetary policy response to the new data was to leave interest rates – one of the components of the monetary conditions – at the current level. The board members also agreed that the need to further ease the monetary conditions had increased compared to the situation six weeks earlier.

It was said that the monetary policy commitment to the 2% inflation target contributes to stabilising the economy. It was said that steps had already been taken to fulfil this target. These steps had included the discontinuation of sales of yields on international reserves, the lowering of monetary policy rates to technical zero and the adoption of a commitment to maintain interest rates at technical zero over a longer horizon until inflation pressures increase significantly. It was said repeatedly that interventions, if made, could act faster than interest rate changes, the scope for which had now been exhausted, and also that the monetary authority’s ability to intervene against the koruna was unlimited. It was said several times that annual monetary-policy relevant inflation had been 0.6% in May, which was below the lower boundary of the tolerance band around the target. It was said that adjusted inflation excluding fuels was constantly negative. It was said that forward-looking monetary policy should respond to current risks. In this regard, several board members spoke in favour of immediately commencing foreign exchange interventions. However, it was also said that the tendency to undershoot the inflation target was only short term in nature and that a necessary condition for commencing interventions was a risk of sustained deflation, which was not materialising.

The Board discussed economic activity and the ensuing risks to the inflation forecast. It was said that the present situation could be described as faltering steps of the economy along the bottom. It was said that the reduction in prices of telecommunication services underlying the historically high deviation in adjusted inflation excluding fuels was a result of sustained downward pressures on inflation, within which oligopolistic structures were being disturbed. It was said that inflationary pressures could not be expected to re-emerge in this context. It was also said that some signs of a turnaround in economic growth were evident – for example better-than-forecasted exports, growth in new orders from abroad and improving consumer sentiment. It was said that the recovery in consumer confidence was a result of the declared end to fiscal consolidation and the stabilisation of inflation and the real purchasing power of households. However, it was also said that amid the current political uncertainty fiscal policy would probably not provide the expected easing over the forecast horizon and that monetary policy would have to take this into account.

The board members discussed household consumption and considered the implications for monetary policy decision-making. It was said that the fall in consumption had probably bottomed out in 2012 H2 and that consumption growth had been less unfavourable in early 2013. This may have been linked with the growth in consumer confidence since September 2012. However, it was also said that household consumption is subject to frequent revisions and also that the importance of consumer sentiment – the decline in which had been successfully stabilised at very low values with the aid of monetary policy – should not be overstated. It was said in the discussion that the saving rate was significantly lower as a result of a recent revision and that the precautionary motive for consumption behaviour was probably at the same level as in 2010. In this regard it was said that the hypothesis of deferred consumption was not being confirmed. However, it was also said that investment in real estate was affecting gross savings and complicating the analysis of change in consumer behaviour. The opinion was expressed that the observed deviation in adjusted inflation might be a sign of a change in consumption behaviour, with households spending less on goods that were previously part of their essential expenditure. However, the opinion was also expressed that the fall in prices of telecommunication services might conversely boost household consumption.

It was argued that signs of labour market adjustment were apparent in the economy. It was said that rising employment amid a falling number of full-time equivalent employees meant an increasing number of part-timers, which was a favourable factor. It was also said that employment was currently rising in non-market services, which the forecast was expecting to be flat over the forecast horizon, and therefore that a sustained labour market recovery could not be expected from this segment.

It was said in the discussion that the forecast was expecting external demand to recover in 2013 H2 and that this was an important condition for a turnaround in domestic economic activity. It was said that the growth prospects of the US economy were more favourable, while the continuing recession in the euro area was not offering good prospects of a sustained recovery and that the expected recovery in external demand was thus still not emerging. However, it was also said that the current rise in consumer confidence in Germany offered a hope that the forecast for a turnaround in external demand might materialise.

The Board discussed the exchange rate and its ability to offset the downside risks to inflation. It was said that as in the past, the exchange rate was adjusting the monetary conditions in the desired direction. It was said in the discussion that the weight of domestic fundamentals in the evolution of the exchange rate was decreasing and that uncertainties reflecting changes in risk aversion around the world and changes in sentiment towards the Central Europe region were gaining ground. In this context, it was said that the exchange rate was slightly weaker than forecasted and was reducing the need to commence interventions. It was said that the exchange rate could remain weaker as a result of bad macroeconomic news and that the weaker exchange rate was also due to interest rate differentials. However, it was also said that the deviation of the exchange rate from the forecast was small and that the exchange rate was merely copying from above the level consistent with the forecast, which was predicting a further easing of the monetary conditions, and therefore that the exchange rate’s potential for easing the monetary conditions more significantly is almost exhausted without further intervention by the monetary authority.

At the close of the meeting the Board decided unanimously to leave the two-week repo rate unchanged at 0.05%. Miroslav Singer, Mojmír Hampl, Vladimír Tomšík, Kamil Janáček, Lubomír Lízal, Pavel Řežábek and Eva Zamrazilová voted in favour of this decision.

Author of the minutes: Kamil Galuščák, Adviser to the Board