Minutes of the Bank Board Meeting on 5 November 2015

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

The meeting opened with a presentation of the seventh situation report and the new macroeconomic forecast covering the horizon up to the end of 2017. Both headline and monetary policy-relevant inflation had decreased in 2015 Q3 and had thus been below the lower boundary of the tolerance band around the Czech National Bank’s target. The main causes of the fall in inflation had been a slowdown in annual food price inflation and an acceleration of the decline in fuel prices. Import prices had remained anti-inflationary owing to a continued decline in foreign producer prices. However, adjusted inflation excluding fuels had gone up slightly despite the subdued inflation abroad. Domestic annual economic growth had risen further to 4.6% in 2015 Q2. All demand components, in particular fixed investment and household consumption, had contributed to this growth. As a result, GDP had approached its potential from below. The labour market recovery had continued – total employment had risen, the unemployment rate had fallen and wage growth had accelerated. Overall, therefore, the domestic economy was fostering higher inflation, whereas the external economy was dampening inflation.

The new forecast 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 the end of 2016. Consistent with the forecast was an increase in market interest rates amid modest appreciation of the koruna in 2017. The return to conventional monetary policy would not imply appreciation of the exchange rate at the forecast horizon to the slightly overvalued level recorded before the CNB started intervening, among other things because the weaker exchange rate of the koruna was in the meantime passing through to domestic prices and other nominal variables. Compared to the previous prediction, the inflation forecast was lower until 2016 Q3 in response to subdued external inflation and lower growth in domestic food prices. As from the end of 2016, by contrast, the inflation forecast had been revised upwards slightly owing to the higher observed domestic economic activity. Headline inflation would thus hit the 2% target at the monetary policy horizon. The forecast assumed continuing robust economic growth for the rest of 2015, aided above all by a positive supply shock due to low oil prices, easy domestic monetary conditions and a recovery in government investment and private consumption. The domestic economy would thus foster growth in the price level over the entire forecast horizon via a continued recovery in wage growth. Next year, however, the growth of the economy would slacken as the effect of the slump in oil prices unwound and government investment and expenditure co-financed from EU funds decreased.

In the discussion that followed the presentation of the situation report, the board members agreed that the risks to the new forecast were broadly balanced. A majority of the board members also expressed their agreement with the overall message of the forecast. There was a consensus that the appropriate monetary policy response was to leave monetary policy rates unchanged at technical zero and that a need to maintain easy monetary conditions persisted. The likelihood that it would be necessary to discontinue the exchange rate commitment earlier than assumed in the forecast was decreasing over time. In this situation, the Board discussed extending the duration of the exchange rate commitment. It agreed that its discontinuation would probably shift to around the end of 2016. All the Board’s earlier statements that it would not discontinue the use of the exchange rate as a monetary policy instrument before the second half of 2016, meanwhile remained valid.

In connection with the extension of the exchange rate commitment, the board members discussed the necessary exit conditions. The opinion was repeatedly expressed that in the present regime, domestic monetary policy was being significantly affected by the ECB’s unconventional monetary policy and that any exit from the CNB’s exchange rate commitment before the ECB’s quantitative easing was discontinued could be very complicated. Given the very low outlook for interest rates abroad, some of the board members expressed doubts about the post-exit rate of growth of domestic interest rates assumed in the forecast. Such growth could lead to a significant increase in the interest rate differential and to unintended excessive appreciation of the koruna, hence there was a consensus that the actual rise in domestic interest rates would probably be slower.

The Board discussed the risks and uncertainties arising from developments abroad. It was said that slowing demand in emerging countries was a downside risk to economic growth and consequently inflation. Materialisation of that risk could contribute, via lower commodity prices, to continued very subdued producer price inflation in the euro area. Some of the board members questioned the mutual consistency of the outlooks for various external variables, in particular the rising outlook for industrial producer prices in the euro area and the very low outlook for foreign interest rates, reflecting the accommodative policy of the ECB. On the one hand, the opinion prevailed that the foreign producer price outlooks had recently been systematically overestimated and might therefore represent a downside risk to inflation, especially at the shorter end of the forecast horizon. On the other hand, however, it was said that the market outlooks for foreign interest rates for 2017 were strongly backward-looking and were well below their monetary policy-neutral level.

In a discussion about domestic economic developments, it was said repeatedly that the growth in domestic economic activity could be regarded as robust and sustainable and there were processes under way that were no longer suggestive of the stag-deflation of past years. The renewal of real convergence of the domestic economy was discussed as well. It was also said that the accelerating domestic economic activity, together with positive labour market developments and continuing growth in business sector wages, would generate inflationary pressures. Against this, it was argued that the current position of the economy on the labour market, as viewed, for example, through the lens of the Beveridge curve, was still quite far from the situation that had existed before the financial crisis erupted. Similarly different were the barriers to growth in industry, where firms still saw insufficient demand as the biggest barrier. The perceived barrier of labour shortages was rising slightly but was still less significant than in 2007–2008. The realisation of major inflation pressures from the domestic economy was thus being suppressed for the time being.

In the context of renewed investment activity, the Board also discussed the acceleration in money aggregate growth and the surge in loans, especially corporate loans with longer maturities. It was said that this surge was occurring amid a noticeable easing of credit standards and a broad decline in average interest margins. Some of the board members pointed out that the rate of money aggregate growth in the Czech Republic was currently higher than that in the euro area. It was argued that if this tendency were to persist in the longer term, it could imply a risk of excessive growth in asset prices and a substantial upside risk to inflation. Against this, however, it was said that the surge in corporate loans was occurring after quite a long period of decline/stagnation, during which firms had been accumulating liquidity, and that the easing of credit standards was consistent with the gradual economic recovery and hence was not dangerous for now. It was also said that it was more appropriate to react to excessive credit growth with macroprudential policy tools.

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 and Jiří Rusnok 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: Michal Hlaváček, Adviser to the Board