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. In line with this, the Czech National Bank still stands ready to intervene automatically, i.e. without the need for an additional decision of the Bank Board, and without any time or volume limits. 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 assumes that market interest rates will be flat at their current very low level and the koruna exchange rate will be used as a monetary policy instrument until the end of 2016. Inflation is still well below the CNB’s target of 2%. According to the forecast, inflation will increase and hit the 2% target at the monetary policy horizon. In 2017, it will be slightly above the target. According to the forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will occur from early 2017. The Bank Board assesses the risks to the new forecast as balanced.
A need to maintain significantly expansionary monetary conditions persists. The likelihood that it will be necessary to discontinue the exchange rate commitment earlier than assumed in the forecast is decreasing over time. In this situation, the Bank Board discussed extending the duration of the exchange rate commitment. It agreed that its discontinuation would probably shift to around the end of 2016. The subsequent return to conventional monetary policy will not imply appreciation of the exchange rate at the monetary policy horizon to the slightly overvalued level recorded before the CNB started intervening, among other things because the weaker exchange rate of the koruna is in the meantime passing through to domestic prices and other nominal variables.
As regards the assumptions of the forecast regarding the external environment, growth in economic activity in the euro area will accelerate slightly further in the near future and fluctuate around 2% over the entire forecast horizon. Industrial producer prices in the euro area are still falling markedly owing to low energy commodity prices and are not expected to return to year-on-year growth until the second half of next year, i.e. later than assumed in the previous forecast. The currently low consumer price inflation in the euro area will rise gradually owing to rising demand and the unwinding of the effect of the slump in oil prices, but will not exceed 2% before the end of 2017. The subdued inflation is reflected in accommodative ECB monetary policy. This is reflected in the outlook for 3M Euribor rates, which remain close to zero over the entire forecast horizon.
The Brent crude oil price has declined recently. According to market outlooks, it should rise slowly. Its outlook has been revised downwards slightly over the entire horizon compared to the previous forecast. Koruna prices of energy will also be affected by the outlook for a gradually weakening exchange rate of the euro against the dollar in 2016.
Domestic headline inflation fell in 2015 Q3 as a result of a marked slowdown in annual food price inflation and an acceleration of the decline in fuel prices. The anti-inflationary effect of import prices stemming from the fall in euro area producer prices and global commodity prices will subside gradually, and import prices will be slightly inflationary in the second half of next year. The growing domestic economy will foster higher costs and consequently higher consumer prices over the entire forecast horizon via accelerating wage growth and rising prices of other inputs. This will be reflected in a gradual rise in headline inflation, which will hit the 2% target at the monetary policy horizon and exceed it slightly in 2017.
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. It will be only slightly lower owing to positive contributions from changes to indirect taxes stemming from further increases in excise duty on tobacco products. It, too, will thus be slightly above the 2% target as from the start of 2017.
Annual growth in the Czech economy picked up further in 2015 Q2. As a result, economic output approached its potential from below. All expenditure components, in particular fixed investment and household consumption, contributed to the year-on-year growth in GDP. The economy will continue to show robust growth for the rest of this year. Low oil prices, easy domestic monetary conditions and higher government investment will lead to GDP growth of 4.7% this year. Next year, economic growth will slow somewhat to just below 3%. This slowdown will be due to a fall in government investment and the unwinding of the effect of the fall in oil prices. The economy will maintain a similar rate of growth in 2017, with positive contributions from all components of domestic demand. The rising economic activity will manifest itself in continued employment growth, which will result in a further decrease in the number of unemployed persons. In this situation, wage growth in the business sector will increase noticeably and wage growth in the non-business sector will slow somewhat from its current high level.
The forecast assumes 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 the end of 2016. Consistent with the forecast is an increase in interest rates amid gradual appreciation of the koruna in 2017.
Compared to the previous forecast, the predictions for headline and monetary policy-relevant inflation are lower until 2016 Q3 owing to lower observed inflation and a lower outlook for foreign producer prices and domestic administered prices. As from the end of 2016, by contrast, the inflation forecast has been revised upwards slightly, reflecting higher domestic economic activity and related stronger upward pressures on costs, especially wages. The inflation outlook is thus slightly higher at the monetary policy horizon compared to the previous forecast. The unexpectedly strong GDP growth so far has led to a marked increase in the GDP growth forecast for this year. However, the economic growth outlook for the next two years is virtually unchanged from the previous forecast. The assumption of flat market interest rates at their current very low level and the use of the exchange rate as a monetary policy instrument until the end of 2016 remains unchanged in the forecast.
The Bank Board assessed the risks to the forecast at the monetary policy horizon as being balanced. Slowing demand in emerging countries is a downside risk to economic growth and consequently inflation. Materialisation of that risk could contribute, via lower global demand and commodity prices, to continued very subdued producer price inflation in the euro area, for which the forecast assumes a recovery. On the other hand, an upside risk to domestic inflation is that the assumed decrease in natural gas prices for households at the start of next year may not materialise. In this situation, the Bank Board discussed extending the duration of the exchange rate commitment. It agreed that its discontinuation would probably shift to around the end of 2016.