Minutes of the Bank Board Meeting on 4 February 2016
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 first 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 towards zero in 2015 Q4, thus remaining well below the CNB’s inflation target. The decrease in inflation had been due to a halt in annual food price growth and a deepening decline in fuel prices. By contrast, adjusted inflation excluding fuels had risen somewhat, with the effect of increasing growth in the domestic economy and wages outweighing a continuing marked decline in foreign producer prices. The Czech economy had expanded by 4.7% year on year in 2015 Q3, with all domestic demand components having made positive contributions, especially fixed investment and household consumption. The growth had been supported by easy monetary conditions, a sharp rise in government investment, growth in external demand and low oil prices.
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 in 2017. The return to conventional monetary policy would not result in the exchange rate appreciating sharply 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 the price level and other nominal variables. The forecast expected renewed food price growth and a moderation of the year-on-year decline in fuel prices to contribute to a renewed increase in inflation already in early 2016. The domestic economy would continue to foster higher costs and consequently higher consumer prices, mainly via accelerating wage growth. At the same time, the current strongly anti-inflationary effect of import prices, stemming from a fall in producer prices in the euro area and in global commodity prices, would fade gradually. Both headline and monetary policy-relevant inflation would thus hit the 2% target at the monetary policy horizon. From mid-2017 they would then fluctuate slightly above the target. According to the forecast, the currently strong GDP growth would slow markedly this year due to a temporary decline in gross capital formation, which would be affected mainly by a fall in government investment financed from EU funds. On the other hand, the economy would be supported by still easy monetary conditions, a further decline in oil prices and rising external demand. The favourable economic developments would be reflected in a further improvement in the labour market situation.
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. The evolution of oil prices was a significant source of uncertainty in both directions. A majority of the board members also expressed their agreement with the overall message of the forecast, including the timing of the discontinuation of the exchange rate commitment. There was a consensus that the domestic economy was now generating inflation pressures, but the external economy was still significantly anti-inflationary. A need to maintain easy monetary conditions at least to the current extent therefore persisted. There was a consensus that the appropriate response was to leave rates unchanged at technical zero. In line with the new forecast, the Board also stated that the Czech National Bank would not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Board considered it likely that the commitment would be discontinued in the first half of next year. At the same time, the Board stated that any exchange rate appreciation following the discontinuation of the exchange rate commitment would be dampened, among other things, by hedging of exchange rate risk by exporters during the existence of the commitment, by the closing of koruna positions by financial investors, and by possible CNB interventions to mitigate exchange rate volatility.
In a discussion about currently observed inflation and the inflation outlook, the Board agreed that the situation was being significantly affected by oil price movements and their subsequent pass-through to headline inflation. In this context, it was said that oil prices were volatile and might now have bottomed out, but even a major increase in oil prices would not lead to a rise in inflation posing a threat to the fulfilment of the target. It was said repeatedly that the fall in oil prices represented a positive supply shock whose first-round effects on inflation were subject to an escape clause. It was mentioned several times in this context that the adjustment of inflation for the first-round effects of a supply shock was captured by adjusted inflation excluding fuels, which was above 1% and had been on an upward trend for a long time. It was also said that the observed difference between headline inflation and adjusted inflation excluding fuels reflected the strongly low-inflation external environment and the long-running easy domestic monetary policy, which had significantly and successfully contributed to a recovery in domestic demand pressures.
The Board went on to discuss domestic economic developments and their effect on inflation. There was a consensus that economic growth was sustainable, despite the temporary slowdown it had recorded this year. It was said that the situation of the domestic economy had changed dramatically since the introduction of the exchange rate commitment and that a robust recovery was now apparent. It was said several times that the fiscal assumption contained in the forecast was not very realistic and that, given the political cycle, fiscal policy would probably foster higher growth, and hence also higher inflation, over the outlook horizon. In an assessment of the overall effect of the domestic economy, it was said that symptoms of quite strong inflation pressures were visible. However, it was said repeatedly that the currently observed macroeconomic indicators were nowhere near the levels seen in the past when the economy had been overheating or getting close to overheating.
In a discussion about the labour market situation, attention was drawn to a number of signals supporting the return of inflation to the inflation target as expected by the forecast. Faster wage growth, employment growth and growth in vacancies were mentioned several times. It was said that wage bargaining was also now indicating stronger upward pressures on inflation. It was also said that industry was facing increasing problems with staff shortages and that the wage cost-to-output ratio was rising. This meant upward pressure on wages and hence also on inflation.
The Board also discussed in detail the impact of the situation abroad on domestic monetary conditions. It was said several times that the easing of monetary policy by the ECB in the form of negative rates and quantitative easing was affecting the domestic monetary policy stance and was being reflected in postponement of the date of exit from the exchange rate commitment. It was also said that the external situation had changed substantially over the last few years and that several central banks had cut their rates to negative levels. In this context, the Board again discussed the possibility of introducing negative interest rates.
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: Michal Franta, Adviser to the Board