Minutes of the Bank Board Meeting on 17 December 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 eighth situation report assessing the new information and its effect on the fulfilment of the forecast contained in the seventh situation report. The forecast had assumed that market interest rates would be flat at their current very low level and the exchange rate would be used as a monetary policy instrument until 2016 Q1. In the light of the new information, the balance of risks to the November forecast was assessed as being anti-inflationary, mainly reflecting developments abroad. After having accelerated during the second and third quarters of this year, annual headline inflation had edged down to 0.6% in November and was 0.2 percentage point lower than forecasted. The published data continued to confirm the CNB’s opinion that the decision made in November 2013 to start using the exchange rate as an additional monetary policy instrument had contributed significantly to averting the threat of deflation linked with a drop in demand.

Real GDP had risen by 2.4% year on year in 2014 Q3. This figure was 0.2 percentage point lower than forecasted. In line with the forecast, all components of domestic demand except net exports had contributed to the year-on-year growth in economic activity. By contrast, net exports had made a slightly negative contribution as a result of rising imports, reflecting, as expected, a recovery in investment activity and household consumption. In quarter-on-quarter terms, economic activity had increased in line with the forecast. The ongoing domestic economic growth was continuing to have a favourable effect on the labour market situation to a degree which exceeded the expectations of the Czech National Bank overall. Only wage growth had been lower than forecasted in Q3. Indicators from the real economy at the start of Q4 were pointing to continued economic growth at the end of this year. According to new information on developments abroad, the outlook for consumer price inflation and especially producer price inflation in the euro area had been lowered over the entire forecast horizon. Prices in the euro area were being affected by lower oil prices, which had fallen by almost one-quarter over the entire outlook compared to the forecast. The decline in oil prices represented a positive supply shock. The outlook for external demand and three-month market interest rates in the euro area was only marginally lower than forecasted. Overall, developments abroad represented a significant anti-inflationary risk for the Czech economy.

In the discussion that followed the presentation of the situation report, a majority of the board members agreed that, overall, the new information represented an anti-inflationary risk to the forecast. There was a consensus that the appropriate response was to leave rates unchanged. The Board repeated that the exchange rate commitment of CZK 27 to the euro could still be considered appropriate and that the Czech National Bank would not discontinue the use of the exchange rate as a monetary policy instrument before 2016.

It was said several times in the discussion that in the light of the new information the current situation from the perspective of the domestic economy was different than a year ago, when the economy had been facing insufficient demand, whereas the risks identified a year ago from the perspective of the euro area had materialised. The domestic economy was on a growth path. It was said that all expenditure components except net exports were contributing to the growth and that compared to the previous year the economy was recording falling unemployment, renewed wage growth, incipient growth in newly provided loans and also, for the first time in five years, positive core inflation. It was said that inflation had rebounded from its constant downward trend and that the use of the exchange rate as a monetary policy instrument had prevented deflation and continuing growth in savings. It was said that the use of the exchange rate commitment had brought stability to the economy, stability that was manifesting itself in rising confidence indicators. However, it was said that domestic economic growth and wage growth were both lower than forecasted and that the year-end data would be crucial for assessing sentiment. It was also said that with the exception of real output, the newly published data on the domestic economy represented a downside risk to inflation. It was said that inflation was rising more slowly and would converge to the 2% target later than expected and could not be expected to overshoot the target at the forecast horizon. It was also said that economic growth was not creating sufficient inflationary pressures as yet and that, on the contrary, disinflationary pressures from abroad were prevailing. In this context, it was said that anti-inflationary risks were gradually building up, and several of the board members described the balance of risks as significantly anti-inflationary. However, it was also said that risk assessment was being hampered by uncertainties stemming from conflicting data on the labour market and rapid changes in some indicators, and that the positive tendencies in the Czech economy meant that there was no risk of deflation.

The Board discussed the uncertainties and risks associated with developments abroad in detail. It was said repeatedly that the euro area was facing low economic growth and low consumer and producer price inflation by comparison with the forecast and that this represented a downside risk to inflation. However, it was said that positive signals were also apparent in the euro area, especially in Germany. It was said that the exchange rate of the euro against the dollar was significantly weaker and that this was having sizeable macroeconomic impacts, and that lower oil prices were also having a positive effect. Doubts were expressed about whether the growth in Germany would be sufficient to generate the necessary growth impulses for the domestic economy. It was said repeatedly that sentiment and outlooks in the euro area could be negatively affected by sudden changes in Russia. However, it was also said that the assessment of the impacts of current developments in the external environment was subject to uncertainty.

The prevailing view in the discussion was that the disinflationary pressures from abroad were associated largely with a positive supply shock in the form of significantly lower-than-forecasted prices of oil and some other energy commodities. It was said that the lower oil prices represented a downside risk to inflation. Some of the board members argued that the shock to oil prices could be short-lived. However, it was said that the fall in oil prices could be longer-lasting and it would then be necessary to consider the monetary policy response. It was said in the discussion that the lower energy prices might also have a positive effect on the income of households and firms. It was said that lower fuel prices would benefit firms in sectors with high fuel consumption. It was also said that wholesale energy prices had long been falling, thanks to which retail prices were being reduced without a negative effect on firms’ margins. However, it was said that it was currently hard to assess how much the supply shock stemming from lower prices of energy commodities was manifesting itself in lower foreign inflation. It was said that a rapid rebound in oil prices to higher levels might foster domestic inflation, but was unlikely to lead to inflation rising to the upper bound of the tolerance band around the inflation target before the end of 2015.

Following the discussion of the effects of the positive supply shock stemming from lower prices of energy commodities, the Board considered the implications for monetary policy decision-making. It was said that in the past, escape clauses, i.e. exemptions from fulfilling the inflation target, had been applied in the opposite direction in response to a supply price shock. It was said that monetary policy responds to second-round effects. It was said repeatedly that the inflation target was the anchor for monetary policy and that if risks materialised a monetary policy response was necessary from the perspective of fulfilment of the inflation target at the forecast horizon. It was said that monetary policy had the exchange rate commitment instrument at its disposal and that this instrument had unlimited possibilities in terms of easing the monetary conditions, which in itself represented a factor stabilising inflation expectations. The prevailing view in the discussion was that only if, in the connection with the positive supply shock, there were to be a long-term increase in deflation pressures from abroad capable of causing a slump in domestic demand, renewed risks of deflation in the Czech economy and a systematic decrease in inflation expectations, would it be necessary to consider moving the exchange rate commitment to a weaker level. It was said that the exchange rate was a coarse instrument by comparison with the interest rate and that at the zero lower bound domestic monetary policy had no support in foreign experience for its actions. It was said that the exchange rate was weaker than forecasted and was accelerating the return of inflation to the 2% target at the forecast horizon.

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 close to CZK 27 to the euro.

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