Minutes of the Bank Board Meeting on 25 September 2014

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

The meeting opened with a presentation of the sixth situation report assessing the new information and its effect on the fulfilment of the forecast contained in the fifth situation report. The forecast had 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 2015 Q3. New data pointed to anti-inflationary risks stemming from abroad and, by contrast, slightly inflationary risks to the forecast from the domestic economy. Overall, therefore, they were consistent with the statement made by the Bank Board in July that it would not discontinue the use of the exchange rate as a monetary policy instrument before 2016. Annual headline inflation had increased to 0.6% in August and was thus 0.2 p.p. higher than forecasted, mainly due to higher food price inflation and a smaller decline in administered prices. Adjusted inflation excluding fuels had continued to edge up, reaching 0.9% in August in line with the forecast. The weakened exchange rate was continuing to affect inflation in line with the assumptions of the forecast. Adjusted for this factor, headline inflation would have been negative.

As expected, annual growth in economic activity had slowed slightly in 2014 Q2. All components of demand except net exports had contributed to the year-on-year increase in GDP. Exports had continued to rise at a strong pace, significantly aided by the weakened koruna. Imports had risen even more strongly owing to a domestic economic recovery driven by consumption and investment. In quarter-on-quarter terms the output of the economy had been unchanged. Annual wage growth had been higher than forecasted in Q2 despite having slowed in the business sector. On the labour market, the number of vacancies was rising and the general unemployment rate was falling at a steady, albeit gradual, pace. Indicators from the real economy at the start of 2014 Q3 were pointing to continued buoyant economic growth. New information on developments abroad, by contrast, had shifted the outlook for foreign consumer prices and economic growth slightly lower this year and the next. The producer price outlook had also been revised significantly downwards for this year. The market outlook for foreign interest rates had shifted to weaker levels in response to a further monetary policy easing by the European Central Bank in September 2014.

In the discussion that followed the presentation of the situation report, a majority of the board members agreed that, overall, the new information continued to represent a slightly anti-inflationary risk to the fulfilment of the forecast. There was a consensus that the appropriate response was to leave rates unchanged. The Board also agreed that the exchange rate commitment of CZK 27 to the euro could still be considered appropriate and that the exchange rate could be expected to be kept close to that level at least until 2016. It was said that while the domestic economy was starting to generate noticeable inflationary pressures, there was uncertainty surrounding price developments abroad, especially in the euro area. It was said repeatedly that continued anti-inflationary developments in the euro area represented an anti-inflationary risk for the domestic economy. It was said several times that the current situation confirmed that the July decision to move the exit from the exchange rate commitment at least to the start of 2016 had been appropriate.

The Board discussed in detail domestic economic developments and their effect on inflation. It was said several times that all the signals from the domestic economy were indicating the onset of economic recovery. It was said that the rapid rise in wages and the forecast for further wage growth were signalling the emergence of the first inflationary pressures in the domestic economy. However, the opinion was also expressed that production capacity was not yet fully utilised and the domestic economy was ceasing to be anti-inflationary rather than having a stronger inflationary effect. In this regard, it was said that it would not be clear that the production capacity limit had been reached until year-on-year investment growth was in double figures for at least two consecutive quarters. The opinion was expressed that economic growth might be mixed across manufacturing sectors and that the current strong growth in the motor vehicle industry might not be maintained in the future. On this point, it was said that although investment activity had so far been concentrated largely in sectors linked with the motor vehicle industry, anecdotal evidence suggested that other sectors were in a growth phase as well. This was also indicated by across-the-board growth in the average wage. It was said that although the economic recovery had so far been less inflationary than predicted, developments in the real economy confirmed that the decision to use the exchange rate had been right. In this regard, it was said that the revenues of export sectors were rising in euro as well as koruna terms, demonstrating the benefits of the weakened exchange rate for those sectors. It was also said that almost a year had passed since the introduction of the exchange rate commitment and that the majority of its direct effects on inflation had now materialised, whereas its second-round effects were still ongoing.

In the discussion of the domestic economy, it was also said that despite improving survey indicators, the consumer confidence indicator had fallen in the past two months and this might affect demand and thus be an anti-inflationary risk. On this point, it was said that sentiment was at very high levels despite this fall. It was also said that the possibility of a sustained fall in sentiment was inconsistent with wage growth expectations in companies, which were strong after a long period of decline. However, the opinion was also expressed that the strong employment dynamics were partially undermined by the fact that around one-fifth of the new jobs were in non-market services. In this context, it was said that growth in demand for more highly skilled workers was now apparent on the labour market and that this would lead to growth in their wages and might foster an acceleration of average annual wage growth of up to 5%, as assumed by the forecast.

The Board went on to discuss the situation abroad. It was said that while the domestic economic situation was not currently subject to major uncertainties, the situation abroad was very unbalanced. It was said several times that the low-inflation environment in the euro area was persisting, as was apparent from a decline in the relevant price indices, expected economic growth and market interest rates. The opinion was expressed that there was uncertainty surrounding the impact of the ECB’s current actions. It was also said that the exchange rate component of the monetary conditions was having a similar effect in the euro area as it was in the Czech economy. The opinion was expressed that despite this, no major inflationary pressures could be expected in the euro area in the near future and so the external environment would continue to have no inflationary effect on the domestic economy. In the discussion of the situation abroad it was also said that besides the absence of robust growth in the euro area, the pace of growth in emerging economies was also declining and that this might delay the onset of the growth phase of the global economy, and thus also of global inflation pressures, despite the recovery of the US economy.

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, 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: Bořek Vašíček, Adviser to the Board