Minutes of the Bank Board Meeting on 1 August 2013

Present at the meeting: Miroslav Singer, Mojmír Hampl, Vladimír Tomšík, Kamil Janáček, Lubomír Lízal, Pavel Řežábek, Eva Zamrazilová. The meeting was also attended by Minister of Finance Jan Fischer.

The meeting opened with a presentation of the fifth situation report and the new macroeconomic forecast covering the horizon to the end of 2015. Headline inflation had dropped further to 1.5% in 2013 Q2 and was thus below the CNB’s inflation target. At 0.8%, monetary-policy relevant inflation was slightly below the lower boundary of the tolerance band around the target. Food prices remained a source of observed inflation, while the contribution of tax changes and administered prices had decreased. Falling oil prices had also contributed to the low inflation. Import prices were slightly inflationary owing to the recent depreciation of the koruna. Developments in the domestic economy, by contrast, were strongly anti-inflationary.

According to the new forecast, headline inflation would be below the 2% target this year, while monetary-policy relevant inflation would be below the lower boundary of the tolerance band around the target. Inflation would fall more markedly below the target in early 2014 after the effect of tax changes dropped out. Both headline and monetary-policy relevant inflation would return slowly towards the target over the monetary policy horizon. GDP would drop by 1.5% this year, but would slowly recover from 2013 Q2 onwards. The Czech economy would grow by about 2% in 2014 thanks to accelerating external demand and the unwinding of the dampening effect of fiscal consolidation. The growth of the domestic economy would then pick up further to 3.3% in 2015. The exchange rate of the koruna against the euro would appreciate only very slowly from its current weak level. Consistent with the forecast was a more significant decline in market interest rates to zero, followed by a rise in rates only in 2015. Given the zero lower bound on monetary policy rates, this implied a need to ease monetary policy further using other instruments.

In the discussion that followed the presentation of the situation report, it was said repeatedly that anti-inflationary factors had accumulated further since the previous situation report, and the arguments for achieving easier monetary conditions had therefore strengthened. Several downside risks to inflation had been identified outside the forecast, in particular the risk of non-materialisation or deferral of the economic recovery in the euro area and the risk of lower energy prices due to lower outlooks for world energy prices and to a potential reduction in support for renewable energy resources. It was said that transaction prices of real estate, which, with the exception of Prague, had recorded a decline, were also a downside risk. The majority of the board members agreed that there were no major upside risks apparent over the entire forecast horizon. However, the opinion was also repeatedly expressed that – owing to the risk of a lower harvest – food prices, which were still rising twice as fast as headline inflation, were a potential upside risk, as were oil prices and therefore also fuel prices. Nevertheless, 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 of technical zero until inflation pressures increase significantly. The majority of the board members also agreed that there was an increasing likelihood of commencing foreign exchange interventions in order to further ease monetary policy.

In a discussion of the need to further ease the monetary conditions in a situation of zero interest rates, several of the board members repeatedly spoke in favour of immediately commencing foreign exchange interventions. It was said that the latest data were strengthening the arguments for foreign exchange interventions. It was said repeatedly that in the current situation, further easing the monetary conditions by means of the exchange rate was an important condition for inflation to return to the inflation target at the monetary policy horizon. The opinion was also expressed that foreign exchange interventions currently represented a necessary condition for stabilising the economic situation. In this regard, it was said that in a situation of zero interest rates the inflation target provides the domestic economy with a nominal anchor only in conditions of appropriate changes in the exchange rate. However, it was noted several times that given the uncertainty about the economic consequences of foreign exchange interventions it was appropriate to wait for a potential greater accumulation of anti-inflationary pressures or for the risk of deflation. Some of the board members described foreign exchange interventions as a possible destabilising element for the domestic economy. In this regard, the Minister of Finance said that while respecting the competences of the two institutions, the Ministry of Finance was not interested in conducting debt management operations that would have repercussions for the conduct of monetary policy and that would endanger the reputation of the Czech Republic overall.

The board members discussed the anchoring of inflation expectations and the risk of deflation. It was said several times that there was no apparent risk of deflation despite the accumulation of anti-inflationary factors, and that inflation expectations were anchored, or not falling. It was mentioned that the money supply was another reason for the low risk of sustained deflation, as year-on-year M2 growth was still close to 4% even in a situation of negative economic growth and low inflation. However, it was also said that there was a risk of deflation unless the monetary conditions were eased further. In this context, it was also noted that for example in Japan, which had experienced the longest period of deflation in post-war history, the evolution of inflation expectations had not signalled the onset of deflation in any way.

The Board discussed domestic economic activity in detail. There was a consensus that the data coming in from the domestic economy were not clear-cut. It was said several times that certain signals indicating the end of the economic recession were visible, such as quarter-on-quarter growth in household consumption and some data from the labour market. It was said that the forecast took these signals into account and that other signals of a possible recovery outside the forecast included some leading indicators, the exception being the indicator of barriers to growth in industry, which was pointing to a growing negative effect of insufficient demand on this sector. In this context, it was noted that leading indicators suggesting a recovery in the past had repeatedly not been confirmed subsequently by published data from the real economy. It was said several times that a negative shock to household consumption might be generated by the depreciation of the exchange rate, owing to rising import prices and falling real wages. Household consumption would then suppress the expected economic recovery. It was also said that the export problem was not the strong koruna, but the weak external demand, and that exporters were constantly emphasising the need for exchange rate stability rather than the need for a weaker exchange rate. It was said that the recovery assumed by the forecast for 2014, which had been revised up by 0.3 percentage point since the previous forecast, constituted a non-inflationary recovery, and so no significant rise in inflation pressures in the domestic economy could be expected in the outlook.

The board members went on to discuss the external situation and the ensuing risks to the inflation forecast. A majority of the board members expressed the opinion that the external outlook assumed by the forecast was too optimistic. For example, doubts were expressed about the consistency of the Consensus Forecasts economic outlook for the euro area, which for 2013 was assuming inflation close to the ECB inflation target at 1.5% simultaneously with a contraction in economic activity of 0.6% in a situation where it was realistic to assume that euro area economic output was well below its potential. It was said that the over-optimistic external outlook represented an anti-inflationary risk outside the forecast. However, several of the board members mentioned the observed signs of an external recovery, for example the improvement in economic sentiment in the euro area and the outlook for Germany. The opinion was expressed, however, that sentiment is subject to sudden changes.

With regard to the external situation, and especially in the context of the tapering of quantitative easing announced by the Federal Reserve, the Board also discussed the evolution of rates at the long end of the yield curve and the impact on domestic monetary policy. It was said that the shift in rates could be viewed as an autonomous tendency towards tighter monetary conditions and that further transmission of this shift, for example to mortgage rates, could be expected. In this context, it was said that the observed rise in rates at the long end of the yield curve implied a need for a more significant easing of the monetary conditions.

The Board also discussed the exchange rate and its ability to offset the anti-inflationary risks as well as the impact of changes in the exchange rate on the real economy. It was said several times that in the long run the weakened exchange rate was adjusting the monetary conditions in the desired direction. In this regard, the opinion was expressed that the modest appreciation reflected a more optimistic outlook for the domestic economy. In the discussion of the impacts of exchange rate changes, the majority of the board members agreed that the impact of the depreciation on the real economy was neutral in the long run. However, it was said several times that the depreciation was significantly contributing to stabilising the economy in the short and medium run via falling real interest rates and improving corporate cash flows and was preventing a fall in inflation expectations.

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. The Board also voted on whether to commence foreign exchange interventions as an additional instrument for easing the monetary conditions and decided not to use this option.

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