Minutes of the Bank Board Meeting on 26 June 2014

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

The meeting opened with a presentation of the fourth situation report assessing the new information and its effect on the fulfilment of the forecast drawn up in the third situation report. The forecast expected market interest rates to be flat at their current very low level and the exchange rate to stay close to CZK 27 to the euro until the start of next year. New data pointed to a slightly anti-inflationary balance of risks to the forecast and, overall, they further increased the need for a later exit from the use of the exchange rate as a monetary policy instrument. Annual headline inflation had increased in May, but had been slightly lower than forecasted, mainly due to lower food price inflation. After having been negative for many years, adjusted inflation excluding fuels had been in positive territory since April 2014, in line with the forecast, and had been slightly higher than forecasted in May. The weakened exchange rate was passing through to inflation in line with the forecast. Adjusted for this effect, headline inflation would have been deep in negative territory.

In line with the forecast, economic growth had picked up pace significantly in the first quarter of this year. All the expenditure components except changes in inventories had grown faster than forecasted. Wage growth had also been higher in 2014 Q1. As expected, wage growth in the business sector had been affected by the wage optimisation observed in late 2012 and early 2013, but was still higher than forecasted. Clear signs of a positive turnaround were visible in the labour market, broadly in line with expectations and in the context of a growing economy. New data signalled a continued economic recovery in 2014 Q2 and confirmed that the anti-inflationary effect of the domestic economy was weakening. In the months ahead, headline inflation would probably be lower than forecasted due to significantly more subdued inflation abroad coupled with mostly non-fundamental factors leading to lower-than-forecasted food prices. The outlook for administrative inflation factors in 2015 had also been reduced compared to the forecast, mainly because of the government’s decision to abolish most of the remaining regulatory fees in health care. Even so, inflation would be close to the 2% inflation target in 2015 after the short-term effects faded out.

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. It was said repeatedly that the November monetary easing had been the right step and that it was passing through to the domestic economy as predicted by the forecast. The opinion was expressed that the domestic economy was adjusting to the changes ensuing from the commencement of use of the exchange rate as a monetary policy instrument. It was said several times that the impacts of the new data on the inflation forecast were not clear-cut. However, it was said that the threat of long-term deflation had been averted by the use of the exchange rate, although the possibility of one-off shocks pushing inflation temporarily into negative figures was not ruled out. In this regard, it was said repeatedly that external anti-inflationary pressures were the main cause of the lower-than-forecasted inflation and that, given the stability of the nominal exchange rate, the real exchange rate was thus less accommodative than expected. There was a consensus that the appropriate response to the new information was to leave rates unchanged at technical zero and to maintain the exchange rate close to CZK 27 to the euro.

It was said repeatedly that, in light of the slight anti-inflationary risks, the assumed maintenance of the exchange rate close to the intervention level did not deliver a monetary easing of the necessary magnitude and that the new data increased the likelihood of a later exit from the use of the exchange rate as a monetary policy instrument. The prevailing view was that the use of the exchange rate as a monetary policy instrument would not be discontinued before 2015 Q2 and that a further postponement of the exit from the exchange rate commitment in the future was not ruled out. In this context, it was said that a later exit from the exchange rate commitment would support the adjustment of the price level and other nominal variables to the new exchange rate level and therefore also support expectations that the exchange rate would not then strengthen abruptly. It was said that it was also not possible to rule out a future need to change the intervention level of the exchange rate in the weaker direction, although the currently observed slight anti-inflationary risks did not warrant such a monetary policy response at present.

The Board discussed domestic economic activity in detail and considered its impact on the inflation forecast. It was said several times that there was clear evidence of a turnaround in economic activity, as indicated by the GDP figures for 2014 Q1. It was said that the recovery was confirmed by continuing retail sales growth. It was said that the figures on sales growth in the motor vehicle segment were even more optimistic than those on real activity and consumer confidence. In a discussion of the structure of consumption, it was said that households in lower income deciles were maintaining balanced budgets despite relatively high housing costs and that new data indicated greater caution as regards consumer credit. It was said that the high volume of announced public orders indicated a larger contribution of fiscal policy to economic growth and that this would compensate for the less-expansionary-than-forecasted fiscal policy in 2015. It was said repeatedly that the economic recovery was not currently being accompanied by visible inflationary pressures. However, it was said that the anchoring of inflation expectations at the 2% target, the second-round effects of the weakened exchange rate and the increasing velocity of monetary aggregates indicated that domestic demand was not being constrained by postponement of consumption and investment.

It was said repeatedly in the discussion that the economic recovery was also manifesting itself in the labour market, primarily as faster wage growth and increasing working hours. It was said that the turnaround in the labour market may have been aided by favourable weather conditions and therefore might not be sustainable. It was said that the increase in working hours might not be long term in nature and that higher job creation and elimination of spare capacity in the labour market was being prevented by high labour taxation. It was said that the domestic economy had long been heading towards labour-saving activities, a trend confirmed by data on the structure of new investment. However, it was said that the higher-than-forecasted wage growth was a positive factor which indicated faster dissipation of the anti-inflationary effect of the domestic economy and the labour market and which might contribute to fulfilment of the monetary policy commitment in the form of low and stable inflation.

The Board discussed external developments, which, given the high degree of openness of the Czech economy, are a key determinant of domestic economic activity and inflation. It was said that in the euro area disinflationary pressures were still evident in consumer and producer prices, which were causing lower domestic inflation via slower growth in import prices. It was said that credit growth in the euro area was low and that external risks were also associated with the effectiveness of the European Central Bank’s recent measures to ease the monetary conditions in the euro area. However, it was said that the growth outlook for the German economy was positive and that the more sustained growth in domestic demand in Germany, confirmed by new consumer confidence data, was a source of hope for sustainable growth in external demand. In this context, it was said that domestic orders were rising quickly this year owing to high growth in foreign orders, and that this was a sign of more sustained growth of the domestic economy.

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, 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 close to CZK 27 to the euro.

Author of the minutes: Kamil Galuščák, Adviser to the Board