Minutes of the Bank Board Meeting on 27 March 2014

Present at the meeting: Miroslav Singer, Mojmír Hampl, Vladimír Tomšík, Kamil Janáček, Lubomír Lízal, Jiří Rusnok, Pavel Řežábek.

The meeting opened with a presentation of the second situation report assessing the new information and its effect on the fulfilment of the forecast drawn up in the first situation report. Overall, the new data confirmed the arguments for the implemented weakening of the exchange rate and for the CNB’s communicated commitment to keep the exchange rate close to CZK 27 to the euro at least until the start of 2015. The second situation report assessed the risks relating to the forecast as being slightly anti-inflationary, pointing to a rather stronger and longer-lasting need to ease the monetary conditions than had been indicated by the first situation report. The new information therefore indicated that the exchange rate commitment would indeed not be discontinued before the start of 2015, and might be discontinued rather later than that.

The domestic economy had bottomed out in the second half of last year. In line with the forecast, economic activity had recovered in 2013 Q4 and even recorded a noticeably stronger rate of growth. All expenditure components except change in inventories had contributed to the annual GDP growth. The main source of the deviation from the forecast had been an increase in fixed investment, which had not been expected by the forecast. Fixed investment does not usually have any immediate inflationary effects, and this time had been no exception. At the start of this year, annual headline inflation had dropped sharply in line with the forecast, reaching very low – albeit positive – levels, with prices increasing by just 0.2% year on year in both January and February. The slight downward deviation from the forecast had been due chiefly to a deeper decline in administered prices. The risks to the current inflation forecast were on the downside mainly because of an unexpectedly large year-on-year decline in nominal wages in the business sector in 2013 Q4. Data adjusted for the expected effect of tax optimisation in late 2012 and early 2013 also pointed to a decline in wages, while the forecast had expected a slight increase. The effect of the domestic economy was thus currently assessed as being rather more anti-inflationary than in the forecast.

In the discussion that followed the presentation of the situation report, a majority of the board members agreed that, overall, the new information represented a slightly anti-inflationary risk to the forecast contained in the first situation report. It was said repeatedly in this regard that the undershooting of the inflation target and the further accumulation of anti-inflationary risks in the domestic economy reflected insufficient monetary easing in past quarters. Looking back, this confirmed that the November easing of the monetary conditions by means of the exchange rate had, in a situation of technical zero rates, been necessary. The opinion was also expressed that some factors, such as the uncertainty about the lag in the transmission of the weakened exchange rate to prices, might make the anti-inflationary message of the new data with respect to the current forecast less clear-cut. However, there was a consensus that the observed slight downside risks to inflation did not justify changing the settings of the monetary conditions, and therefore that the appropriate response was to leave rates unchanged and to continue maintaining the exchange rate close to CZK 27 to the euro. It was also noted that the current very low 3M PRIBOR rates, reflecting their very low spread vis-à-vis the 2W repo rate, and the exchange rate indicated that monetary policy was currently delivering the necessary easing of the monetary conditions.

A majority of the board members felt that in light of the new information it was important to reaffirm that the level of the exchange rate commitment at CZK 27 to the euro was appropriate, since the exchange rate at this level was continuing to ensure that the monetary conditions would be eased to the necessary extent. There was a consensus that the new information confirmed previous communications that the use of the exchange rate as a monetary policy instrument would continue at least until the start of 2015. In this context, it was said that it was important to emphasise the one-sided nature of both parameters of the exchange rate regime, i.e. the exchange rate level commitment, which sets a lower bound on the koruna-euro rate, and the end-date commitment, where the start of 2015 represents the minimum duration of the commitment. It was also said that it was appropriate to repeatedly point out that the monetary policy objective was unchanged and was still to set the monetary conditions in such a way as to ensure that the inflation target would be achieved with sufficient probability at the monetary policy horizon in a sustainable fashion.

The Board discussed the domestic factors underlying inflation. There was a consensus that the domestic economy was having a rather more anti-inflationary effect than forecasted thanks to the labour market situation. It was said that the surprise fall in the average nominal wage in the business sector in 2013 Q4 had reduced the inflation outlook for this year and the next and thus represented a downside risk to inflation. In the debate on the reasons for the fall in wages, attention was drawn several times to the possible link with the economic recovery – more low-income workers were being hired and this was leading to a fall in the average wage. Attention was also drawn to the inconsistency between the surprise fall in wages on the one hand and the modest positive surprise in household consumption on the other hand. In this regard, mention was made of the growth in retail sales, especially in the automotive segment, which, conversely, was consistent with growth in consumption. It was also said that the observed consumption behaviour of households was consistent with the permanent income hypothesis, according to which households smooth out their consumption in response to a swing in income caused by falling wages.

In its discussion, the Board also paid great attention to the significant recovery of the domestic economy observed in 2013 Q4. Some of the board members expressed uncertainty about the interpretation of fixed investment growth underlying the unexpected GDP growth. It was said that the fixed investment growth was linked with the bottoming out of the domestic economy and with the recovery in industry, retail and construction. It was repeatedly noted that the unexpected growth in fixed investment towards the end of last year may have been one-off in nature and linked, for example, with the commencement of interventions, when a pick-up in purchasing may have occurred, as observed in the case of household consumption. The other reasons given for the one-off growth in fixed investment were faster drawdown of money from European funds at the end of the year and the launch of new models in the automotive industry. A possible interpretation based on a correction of the sharper decline in fixed investment recorded during the last domestic recession was also mentioned. The Board agreed that the structure of the major positive surprise in domestic economic growth due to unexpected fixed investment growth was non-inflationary.

It was mentioned several times that the surprise recovery of the Czech economy had occurred in a situation of lower-than-expected inflation. This clearly indicated a significant and long-running negative output gap and an environment of very subdued inflation pressures and wages, which had probably been showing deflationary tendencies. The deflationary tendencies on the labour market were also posited as a possible explanation of the observed decline in wages in 2013 Q4. In this context it was noted that the arguments against the occurrence of deflationary tendencies in the domestic economy based on expectations of inflation risks had not been confirmed. It was also said that the negative output gap might be a Europe-wide problem whose reflection could be seen in import prices and industrial producer prices. The developments in these price categories indicated that part of the exchange rate weakening was impacting on foreign suppliers.
The Board also discussed developments abroad and agreed that the external environment currently represented a combination of uncertainties and downside risks to inflation. It was said repeatedly that the economic situation in the euro area represented rather a downside risk, as signalled by euro area financial market rates. It was also said that the anti-inflationary risk associated with future developments in the euro area was significant. Moreover, it was being magnified by the potential use of negative interest rates to ease monetary policy in the euro area. The Board also discussed the uncertainties stemming from developments in Ukraine, but these were not currently quantifiable in terms of their effect on domestic inflation.

In a discussion of monetary developments, some of the board members debated the current money aggregate growth figures and the difference in their dynamics compared to the euro area. In this regard, the opinion was expressed that the higher M3 growth compared to the euro area reflected liquidity hoarding by the domestic corporate sector. In a discussion of the withdrawal of state deposits from CNB accounts, it was said that these movements might have an impact on the financial markets, which would be reflected in the domestic monetary conditions. By contrast, however, it was noted that a large proportion of these funds were denominated in euros, so the impacts on domestic monetary policy would be negligible.

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, Jiří Rusnok and Pavel Řežábek 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: Michal Franta, Adviser to the Board