Transcript of the introductory statement from the press conference - 7 November 2013

GOVERNOR

After discussing the situation report, the Bank Board decided unanimously to leave the repo rate at what is in fact technical zero. We will keep it there over the longer horizon until inflation pressures increase significantly. At this moment, the forecast predicts no such thing. No risks of such an increase have been identified. The Bank Board also decided to start using the exchange rate as an additional instrument for easing the monetary conditions. We will intervene on the foreign exchange market to weaken the koruna so as to keep the exchange rate of the koruna against the euro close to CZK 27/EUR.

The reasons for the decision, very simply: consistent with the forecast is a significant decline in market interest rates well below zero – which of course we are unable to attain, we cannot reach such negative levels – followed by a rise in rates above the current levels only at the end of 2014. I would like to point out that the current levels are in fact negative, i.e. we should already be maintaining negative interest rates now. Given the zero lower bound on monetary policy interest rates, the forecast points to a need to ease monetary policy using other instruments. An alternative scenario quantifying the use of the exchange rate of the koruna confirms that a sustained weakening of the exchange rate is an effective instrument for accelerating the return of inflation towards the target.

Up to now we have used our standard instruments. We have reduced key interest rates to technical zero. However, in order to avoid a long-term undershooting of the inflation target and to speed up the return to a situation in which we will again be able to use our standard instrument, i.e. interest rates, which as I said are now at technical zero, we have started to use the exchange rate as an additional monetary policy instrument. As regards duration and volume, it should be said that we are able to intervene against the koruna without limitations. This means we will intervene in the volume and for the duration needed in order to achieve the exchange rate we have specified and thereby hit the inflation target in the future.

Turning to the baseline scenario of the forecast, it is a scenario which assumes negative interest rates. And it is a scenario we have come to regard as so unrealistic that we have had to switch to an alternative one. So, I will describe what – as outlined here – made us say that we cannot go this way, that we can no longer ignore the need for negative rates as indicated in the baseline scenario. We decided to use an alternative scenario which assumes exchange rate interventions and which therefore becomes, from the perspective of the Bank Board, most certainly the most likely description of expected future developments.

I will now summarise the forecast. In addition to tax changes, food prices and administered prices remain sources of inflation. All their contributions to inflation are decreasing. The domestic economy remains anti-inflationary. Inflation will fall to zero in early 2014. After some time it will go up again towards the target, provided that we do what is needed. GDP will drop by less than 1% this year. A gradual recovery has been observed since Q2. According to the forecast, the economy will grow by 1.5% next year and then by 3% in 2015. However, consistent with the forecast is a significant decline in market interest rates – which should already basically be negative – further below zero and a rise in rates only at the end of 2014.

As for the comparison of the external environment assumptions for the euro area, I would not put too much emphasis on changes in consumer prices or producer prices, which are expected to decrease. I would stress that at this moment we now have the ECB’s decision, which confirms that the expectations entering the forecast as regards the EURIBOR and the outlook for the European economy will not materialise. Let me point out that we did not have this at our disposal when we adopted our decision. However, it was possible – or at least in the debate it was highlighted as a risk that the European Central Bank could also decide to ease the monetary conditions further, which is what it did, as we now know from its press release.

Turning to the comparison of the outlook for energy prices, no dramatic change has occurred, only a slight upward adjustment. Even for the exchange rate the change is not significant. I repeat again that we are now looking at the assumptions of the forecast scenario which we decided not to accept.

This is the baseline scenario, where you can see that the inflation forecast shifts to zero. This is the baseline scenario with negative, i.e. unattainable, rates.

The forecast for monetary-policy relevant inflation drops below zero.

The GDP forecast – again, as I said, with unrealistically negative rates – is doing what I have already said. And this, in my view, is the slide that made the Bank Board decide how it decided. For the first time in the forecast, even three-month rates – not those we influence, but those which are currently about 0.5% higher than those we influence – drop below zero for a long time. This is the first time in history that even the three-month rates that are consistent with the baseline scenario of the forecast decline below zero, i.e. to negative levels, for quite a significant period of time.

Linked with this is the forecast for the exchange rate, which should fluctuate around 25 amid negative levels of both our rates and three-month market rates.

Turning to the comparison with the previous forecast, we still reach – and this is important – a lower price level in 2014 under these conditions. GDP is little changed, but it changes downwards in both 2014 and 2015. I have already commented on the rates. The exchange rate does not show major changes under such an unrealistic scenario.

Now I will get down to describing why we have abandoned this scenario and to describing the scenario that we have decided to try to implement.

The alternative scenario took into account the fact that the room for lowering monetary-policy rates has naturally been exhausted, and has been exhausted for some time. The stabilising role of monetary policy for an inflation-targeting central bank must be taken over by another instrument. In our case, it is the exchange rate of the koruna. Consequently, we will be intervening to keep the exchange rate of the koruna against the euro close to CZK 27 against the euro. This will facilitate an earlier return of headline and monetary-policy relevant inflation to the 2% inflation target even with interest rates at the zero lower bound. Of course, GDP growth recovers more quickly at the shorter horizon compared to the baseline scenario.

Let me indicate some of this. The alternative scenario, the one we have opted for, is indicated here with the dashed line, because it is a scenario that we have not implemented in 11 years, not even in the sense of interventions, although interventions were used at that time for a different purpose. The interventions at that time prevented a strong and sharp appreciation of the exchange rate. We are currently using the exchange rate as an instrument for hitting the inflation target. So it is a different case. Despite this, as I have said, we have not intervened in that sense for 11 years. Of course, we are not presenting fan charts either. We are showing only the line that we are expecting.

As you can see, interest rates remain at zero for a very long time, even given our interventions.

At the moment, we are increasing inflation through these interventions so that it returns more quickly into our tolerance band for inflation, i.e. 2% ± 1%. As a result of the interventions – or to be more precise, as a result of using the exchange rate, GDP reaches higher levels.

When comparing the alternative scenario, please note the previous forecast is the dark blue chart, the new forecast is the middle column and the alternative scenario is the light blue column to the right. Consumer prices – let alone monetary-policy relevant inflation – should thus reach the tolerance band earlier. Of course, GDP will strengthen in the short term and – I would like to point out – will rise in the accumulated aggregate, i.e. in the aggregate several years ahead. The three-month PRIBOR could thus reach levels which do not indicate negative rates in the foreseeable future. And, of course, the exchange rate against the euro in this scenario – and this is a model assumption – must get where we want it, because we – as those who are able to introduce korunas onto the market as we like – have unlimited possibilities in this sense.

I’d like to finish the presentation here and give room for your questions. Just one more remark: at the moment, the Bank Board has rejected the baseline scenario of the Situation Report by opting for the alternative scenario. However, I presume that the next Situation Report will be written from the point of view of what we are doing as the baseline scenario. This means that we may offer more information. Of course, the structure of the Situation Report, which is a report for analysts, will be rather different from the report they will obtain next week. It will work with the baseline scenario, but it will also incorporate that fact that the Bank Board has rejected it and opted for a different scenario. So, next time, the scenario that the Bank Board has opted for and the intervention scenario will form the core of the Situation Report.