Minutes of the Bank Board Meeting on 17 December 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 eighth situation report assessing the new information and its effect on the fulfilment of the inflation forecast drawn up in the seventh situation report. The eighth situation report assessed the risks relating to the forecast as being very slightly anti-inflationary. The new information therefore pointed to a rather stronger and longer-lasting need to ease the monetary conditions than had been indicated by the seventh situation report. The easing of the monetary conditions that had been undertaken via a weakening of the exchange rate of the koruna after the Bank Board’s November meeting was therefore appropriate to the current situation. Overall, the new data confirmed previous communication that the CNB would keep the exchange rate close to CZK 27/EUR at least until the start of 2015. The weakening of the koruna exchange rate undertaken in November was significantly reducing the risk of sustained deflation and would accelerate the return of inflation towards the CNB’s target and speed up the recovery of the domestic economy. According to the quantification contained in the previous situation report, gross domestic product would rise by 2.1% in 2014 thanks to the weaker exchange rate, whereas the economic recovery would have been more than one percentage point slower had no monetary policy action been taken.

The Czech economy was still close to the trough of the business cycle and operating well below its potential. The year-on-year real GDP contraction had moderated further in 2013 Q3 (to -1.3%), but economic activity had switched back to a slight decline in quarter on quarter terms. The forecast contained in the seventh situation report had meanwhile expected a more marked moderation of the year-on-year GDP contraction for Q3 amid continued modest quarter-on-quarter growth. This deviation from the forecast had been due most of all to an unexpected negative contribution of net exports, and household consumption had also been lower than predicted by the CNB. The severely underperforming economy, coupled with a persisting downturn on the labour market, was continuing to be reflected in deflationary tendencies. No cost-push inflation pressures were apparent in the domestic economy either. The short-term outlook for administered prices was continuing to edge downwards. Falling agricultural producer prices would cause food price inflation to go down. Headline inflation (1.1%) and monetary-policy relevant inflation (0.3%) were slightly below the CNB’s expectations so far in 2013 Q4 (by 0.1 percentage point in November). Headline inflation was at the lower boundary of the tolerance band around the CNB target and monetary-policy relevant inflation remained well below the lower boundary of the tolerance band. The deviation from the forecast in November had been due mainly to lower-than-expected annual food price inflation. As for developments abroad, the outlook for sustained accommodative ECB monetary policy, reflecting growing deflationary risks in the euro area, was particularly significant.

In the Bank Board’s discussion that followed the presentation of the situation report, the prevailing opinion was that the newly available information had confirmed the message of the forecast contained in the seventh situation report and that the risks by comparison with both the baseline and alternative forecast scenarios were still accumulating very moderately on the downside and that easing the monetary conditions using the exchange rate in a situation of zero interest rates had therefore certainly been the necessary response to domestic economic developments. However, it was also said that the interventions could have been postponed and that their introduction had encumbered the economy with additional uncertainty and might have an adverse impact on consumer demand and the renewal of investment. On the other hand, it was also said that the easing of the monetary conditions should have happened earlier, because monetary policy should be forward-looking and not wait for deflationary risks to materialise. In this context, it was said that a delayed monetary policy easing might have come at the cost of more deeply anchored deflationary expectations, which were contributing to the economic contraction. It was said that the interventions could not entirely prevent deflation, but were very significantly reducing the risk of long-term deflation.

A majority of the board members felt that in light of the new information, the commitment to keep the exchange rate close to CZK 27/EUR at least until the start of 2015 needed to be confirmed. There was a consensus that the commencement of use of the exchange rate as an instrument had preordained further monetary policy actions, as a rapid exit from the use of the exchange rate as an additional instrument might be counterproductive given the possibility of an abrupt strengthening of the exchange rate. In this regard, it was said that uncertainty associated with the exchange rate level at the time of exiting the interventions might negatively affect investment. However, it was also said that the exit strategy was also captured in the current model simulations. It was also said that the point of using the exchange rate to ease the monetary conditions was to accelerate the return to standard monetary policy-making.

The Bank Board went on to discuss the domestic factors underlying inflation and agreed that the domestic economy was not inflationary in its effect. The economy was below its potential and was not emerging from the trough of the business cycle, and domestic demand was depressed. It was said that there were no inflationary pressures apparent in the labour market either. However, it was also said that the available information implied only a short period of deflation, in which falling energy prices would play a significant role, which was positive for the economy. It was said that the pass-through of the exchange rate weakening to prices could be relatively fast. On the other hand, the opinion was expressed that without an easing of the monetary conditions there had been a risk of much longer-lasting deflation, that deflationary tendencies were evident from the five-year deflation of market prices, and that the fall in energy prices had merely provided an additional impetus.

The Bank Board also discussed developments abroad and agreed that they would be an important factor for the domestic economy. It was said that external demand had so far contributed the most significantly to the moderation of the contraction in GDP. It was also said that the latest available information was, however, signalling a risk of a further slowdown in growth in the euro area and also a risk of deflation in the euro area and that those signals represented a downside risk to inflation for the very open Czech economy. It was said that the crisis had been overcome most quickly by developed economies applying forward-looking and sufficiently accommodative monetary policy and that it was necessary to draw on their experience of dealing with the impacts of the economic crisis.

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 decided to continue using the exchange rate as an additional instrument for easing the monetary conditions and confirmed the CNB’s commitment to intervene in the foreign exchange market to weaken the exchange rate so as to keep the exchange rate of the koruna against the euro close to CZK 27/EUR.

Author of the minutes: Kateřina Šmídková, Adviser to the Board