Statement of the Bank Board for the press conference following the monetary policy meeting

At its meeting today, the Bank Board of the Czech National Bank decided unanimously to keep interest rates unchanged at technical zero. The Bank 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 on the foreign exchange market if needed to weaken the koruna so that the exchange rate of the koruna is kept close to CZK 27 to the euro. The asymmetric nature of this exchange rate commitment, i.e. the willingness only to intervene against appreciation of the koruna below the announced level, is unchanged.

This decision is underpinned by a new macroeconomic forecast. The forecast is based on the assumption that market interest rates will be flat at their current very low level and the exchange rate will be used as a monetary policy instrument until 2016 Q1. The subsequent return to conventional monetary policy will not imply appreciation of the exchange rate to the level recorded before the CNB started intervening, as the weaker exchange rate of the koruna is in the meantime passing through to prices and other nominal variables. The forecast expects inflation to continue rising gradually and exceed the 2% target at the start of 2016. The Bank Board considers the risks to the new forecast to be balanced. In this situation, the Bank Board repeated that the Czech National Bank would not discontinue the use of the exchange rate as a monetary policy instrument before 2016.

Turning to the forecast assumptions regarding developments abroad, the currently weakening growth in euro area economic activity can be expected to accelerate significantly again in the course of 2015. Foreign producer prices are falling sharply this year, reflecting the previous long-running contraction in economic activity and currently low commodity prices. For the same reasons, euro area consumer price inflation is very low this year. Foreign producer and consumer price inflation is expected to pick up in 2015 thanks to an increase in economic growth and a weakening exchange rate of the euro against the US dollar. The very subdued inflation in the euro area and the related recent easing of monetary policy by the European Central Bank using unconventional instruments are reflected in a low outlook for foreign interest rates. Overall, the outlook for the euro area in the rest of this year and for next year has shifted towards slower economic growth and lower inflation.

The euro is expected to continue depreciating against the US dollar in the next two years. A decrease in the dollar price of Brent crude oil in 2015 and 2016 reflects its current considerably reduced level. Overall, these shifts in the external environment are having a marked anti-inflationary effect on the forecast for the Czech economy. However, the lower outlook for oil prices simultaneously represents a favourable pro-growth supply-side impulse.

Looking at developments in the Czech economy, inflation rebounded from near-zero levels in recent months, but remained below the lower boundary of the tolerance band around the Czech National Bank’s target. The low inflation was due to a continuing decline in administered prices and subdued inflation in the euro area. The weakened exchange rate is still feeding through to inflation via import prices. Moreover, the domestic economy is now pushing prices upwards. The forecast expects headline inflation to continue rising gradually and slightly exceed the 2% target at the start of 2016. The inflationary effect of import prices will fade at the end of this year owing to the observed fall in producer prices in the euro area amid a stable exchange rate of the koruna. By contrast, the domestic economy will increasingly contribute to price growth, mainly as a result of accelerating wage growth.

Monetary-policy relevant inflation, i.e. inflation adjusted for the first-round effects of changes to indirect taxes, will follow a similar path to headline inflation next year, although at a slightly lower level. In 2016 it will be the same as headline inflation, standing above the 2% target.

Following a decline in GDP in the past two years, the Czech economy will grow by 2.5% this year according to the forecast. Domestic economic growth will be fostered by higher external demand, the strong easing of the domestic monetary conditions via the weakened exchange rate of the koruna and exceptionally low interest rates, and a recovery in government investment. The economy will show the same growth rate in 2015 and accelerate slightly in 2016. The growing economy is already manifesting itself in the labour market in renewed growth in the number of employees converted into full-time equivalents. This growth will continue over the next two years. New jobs are being created and the number of vacancies is at its highest level in more than five years. The unemployment rate will therefore continue to decrease gradually. Wage growth in the business sector will increase noticeably, and the same will apply to wages in the non-business sector in the near future.

The forecast expects market interest rates to be flat at their current very low level and the koruna exchange rate to be used as a monetary policy instrument until 2016 Q1. By then, thanks to the economic recovery and rising wages, domestic inflation pressures should be sufficiently restored to allow a return to conventional monetary policy. However, this return should not result in the exchange rate appreciating to the level recorded before the Czech National Bank started intervening, as the weaker exchange rate of the koruna is in the meantime passing through to the price level and other nominal variables. Short-term market rates are forecasted to increase by around 0.8 percentage point in 2016 Q2, after the exit from the regime of using the exchange rate as a monetary policy instrument. Market interest rates will then rise further.

The forecasts for headline and monetary-policy relevant inflation are lower than in the previous prediction until early 2016, owing to a lower outlook for net inflation. GDP growth has been revised downwards for 2014 and 2015, mainly on account of a lower outlook for external demand. The expected growth rate of nominal wages in the business sector has also shifted slightly lower for both 2014 and 2015, reflecting a more gradual return of inflation to the target and expected slightly less pronounced domestic economic growth. The interest rate path mainly reflects a stronger anti-inflationary effect of the external economy and domestic administered prices and a related postponement of the expected exit from the use of the exchange rate as a monetary policy instrument.

The Bank Board considers the risks to the new forecast to be balanced. The inflation forecast for the rest of 2014 and for 2015 has shifted markedly lower, reflecting the very subdued inflation in the euro area. At the same time, the weaker current exchange rate level relative to the announced commitment is not only helping to return inflation to the 2% target, but also fostering continued sustainable growth of the economy. In this situation, the Bank Board repeated that the Czech National Bank would not discontinue the use of the exchange rate as a monetary policy instrument before 2016.

A year has passed since the Czech National Bank announced its exchange rate commitment. With this hindsight, we can perform a more comprehensive assessment of the effect of the exchange rate commitment on the Czech economy. The key macroeconomic indicators have been developing much more favourably this year than they were before November 2013. Inflation adjusted for tax changes has stepped back from the edge of deflation. GDP has switched from decline to noticeable growth – its year-on-year growth rate in the first half of 2014 was more than four percentage points higher than in the same period of last year. This is having a favourable effect on the labour market and household and business confidence. Key economic data thus suggest that the weakening of the exchange rate has served its purpose. In the light of new data on developments abroad, the threat of long-term deflation – and a related lengthier recession of the Czech economy, unfavourable wage developments and loss of employment opportunities – was even greater than suggested by the analyses available a year ago.