Minutes of the Bank Board Meeting on 6 February 2014

Present at the meeting: Miroslav Singer, Vladimír Tomšík, Kamil Janáček, Lubomír Lízal, Pavel Řežábek, Eva Zamrazilová.

The meeting opened with a presentation of the first situation report and the new macroeconomic forecast covering the horizon up to the end of 2015. In 2013 Q4, headline inflation had been in the lower half of the tolerance band around the target and monetary-policy relevant inflation had been well below the lower boundary of the band. During Q4, however, annual inflation had recorded an increase linked with the weakening of the exchange rate, which had been reflected in all market components of inflation, while administered price inflation had slowed further. The Czech economy had contracted by 1.2% year on year in 2013 Q3 owing to a decrease in net exports and a continued fall in gross fixed capital formation. In quarter on quarter terms, economic activity had risen slightly for the second quarter in a row, but the output gap had remained strongly negative. The domestic economy thus remained anti-inflationary in a context of very low nominal wage growth.

The new forecast was based on an assumption of stable market interest rates at the current very low level and a flat exchange rate of the koruna close to CZK 27 to the euro until the start of next year. The message of the forecast confirmed that the decision made in November to start using the exchange rate as an additional instrument for easing the monetary conditions had significantly contributed to averting the threat of deflation. The forecast was expecting a still sizeable decline in headline inflation to low – but positive – levels at the start of this year. Inflation would then pick up pace, returning towards the 2% target at the end of this year. This would initially reflect rising import prices connected with the weakening of the koruna and, starting in the second half of this year, an economic recovery and faster wage growth as well. The forecast was expecting inflation to reach 1.2% on average this year. Inflation would increase further at the start of next year amid renewed growth in administered prices, reaching the upper half of the tolerance band around the target at the monetary policy horizon. It would then return to the 2% target from above. Monetary-policy relevant inflation would move in parallel with headline inflation, only at a slightly lower level. Following a decline in the previous two years, the economy would grow by 2.2% this year on the back of higher growth in external demand and the monetary policy easing executed via the weakening of the koruna exchange rate. In 2015 the growth rate of the domestic economy would rise to 2.8%.

In the discussion that followed the presentation of the new forecast, the prevailing opinion was that the risks to the forecast were balanced. There was a consensus that the appropriate response was to leave rates unchanged. It was also said, however, that the risks to the forecast were slightly anti-inflationary but did not justify changing the settings of the monetary conditions. It was said repeatedly that the November easing of the monetary conditions by means of the exchange rate had, in a situation of technically zero rates, clearly been the necessary response to domestic economic developments and that the monetary conditions had been eased to the necessary extent. It was said that monetary policy had a statutory mandate to maintain price stability in the form of the inflation target and that as regards hitting that target, the deviation in inflation had been large and the risk of deflation high. This was evidenced by the figures on adjusted inflation excluding fuels, which had been in deflation for five years and which had remained negative in 2013 Q4. It was said that the decision to commence interventions had helped to significantly reduce the risk of deflation and would lead to a faster return of inflation to the target. It was also said that the evidence clearly showed that the monetary policy easing had been late.

The opinion was repeatedly expressed that in light of the new forecast it was necessary to confirm the commitment to maintain the exchange rate close to CZK 27 to the euro at least until the start of 2015. It was said that thanks to the credibility gained, the announcement of the exchange rate commitment would lead to the exchange rate fluctuating above this level. It was said that if inflation overshot the target more significantly at the forecast horizon, which the forecast did not expect to happen, monetary policy had more instruments at its disposal for a correction than in the case of deflation, and that this confirmed that the decision to use the exchange rate as an additional instrument for easing the monetary conditions had been right.

It was said in the discussion that the forecast was giving out clear signals of an economic recovery, but that even in the intervention regime the domestic economy remained anti-inflationary. This was evidenced by the strongly negative output gap, which would close only gradually over the forecast horizon. The current inflation pressures were therefore only cost pressures. However, it was also said that the signs of economic recovery were apparent only from soft data, while hard data were not yet clearly indicating a recovery. It was said that growth in economic activity depended heavily on the auto industry, whose production is affected by new model roll-out strategies, which had had a negative impact on growth last year. In this regard it was said repeatedly that the growth prospects of the economy were favourable. It was also said that the good condition of industry was evidenced by rapid growth in orders, which the weakening of the exchange rate had also contributed to. In a discussion of the causes of the longest-ever recession of the Czech economy, low household consumption and low public sector investment were mentioned. It was said that fiscal consolidation had had a negative impact on growth in several past years, but that the necessary structural reforms had not yet been made. It was said that fiscal policy would probably remain procyclical.

In a discussion of the economic growth outlook from the perspective of expenditure components, it was said that fixed investment growth could be lower than forecasted and that the assumed renewal of corporate investment could happen later than forecasted, partly due to expectations that the exchange rate would strengthen after the interventions were ended. However, it was said repeatedly that favourable indicators of the financial condition of corporations were suggesting that the fixed investment recovery starting in 2014 H2 assumed in the forecast was realistic. Banks’ willingness to fund new projects was mentioned in support of the argument regarding rapid growth in fixed investment. With regard to the currently deferred fixed investment, which is import intensive, it was said that foreign trade was in surplus and also that foreign trade was the component of aggregate demand where the largest positive effect of the weakened exchange rate could already be expected. It was said that the long-running favourable figures on net exports – the largest component of aggregate demand contributing to GDP growth – represented a risk of excessive appreciation, which could bring the emerging economic recovery to a halt, and that this confirmed that the decision to start using the exchange rate as an additional monetary policy instrument had been right. It was also said that the assumed renewal of fixed investment would help stabilise net exports and thereby curb the appreciation pressures. It was also said that the exchange rate weakening was creating favourable conditions for investment from abroad.

The Board discussed in detail the labour market and household consumption, the outlooks for which were an important forecast assumption for the dissipation of the anti-inflationary effect of the domestic economy. It was said repeatedly that wage growth would be lower than forecasted, as also indicated by information on collective bargaining, and that the labour market improvement might occur later, which was a downside risk to inflation. However, it was also said that incomes might rise via a lengthening of the currently shortened working hours and that the growth in employment might happen later. It was also said in the discussion that household consumption would not be significantly supported this year by pensions and other social benefits either, which was a risk to real consumption. It was said that private consumption was also being curbed by the weaker exchange rate and that the negative income effect was manifesting itself in a decline in sales of food and fuels, which might be sustained in nature. However, it was also said that surveys were indicating a lower willingness to save and a halt in expectations of a further decline in prices, which had been one of the aims of easing the monetary conditions. It was also said that since the start of the crisis there had been a significant rise in savings, albeit uneven across income groups, and that this was creating room for higher-than-forecasted growth in private consumption. It was said repeatedly that certain segments of the economy might recover faster than forecasted.

The Board discussed developments abroad, which are an important factor for growth of the domestic economy. It was said that the growth outlook in Europe was less optimistic and that a major recovery could not be expected in most other countries either. It was said that the inflation outlooks in the euro area were mixed and inflation pressures were not arising. It was said that in some euro area countries inflation was well below the ECB’s target and that continued accommodative monetary policy in the euro area in the future would be reflected in falling outlooks for foreign market interest rates. It was also said that the uncertainty and volatility stemming from abroad represented a risk to the exchange rate in both directions. However, it was also said that a major negative external shock representing an anti-inflationary risk to the forecast was unlikely to occur over the forecast horizon. It was also said that the growth outlook for the euro area countries on which Czech economic growth is most dependent was favourable, even though some of them would have to undergo fiscal consolidation, which might hamper their growth, and that the external risks were balanced overall.

At the close of the meeting the Board decided unanimously to leave the two-week repo rate unchanged at 0.05%. Miroslav Singer, 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 if needed 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: Kamil Galuščák, Adviser to the Board