Minutes of the Bank Board Meeting on 31 March 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 second situation report assessing the new information and its effect on the fulfilment of the forecast contained in the first situation report. The forecast assumed that market interest rates would be flat at their current very low level and the koruna exchange rate would be used as a monetary policy instrument until the end of 2016. Annual headline inflation had increased at the start of this year, reaching 0.5% in February. This was 0.3 percentage point below the forecast contained in the first situation report. The deviation from the forecast had been due mostly to food prices, which had continued to decline year on year, whereas the forecast had predicted renewed annual growth. Adjusted inflation excluding fuels had also been slightly lower than forecasted. However, its level above 1% continued to reflect the effect of the growing domestic economy and accelerating wage growth. The year-on-year decline in fuel prices had been rather deeper than forecasted but had contributed negligibly to the deviation of inflation from the forecast. By contrast, administered prices had gone up as a result of an unexpected rise in electricity prices for households and a smaller-than-forecasted decline in natural gas prices, whereas the forecast had expected them to stay broadly flat.

The annual growth rate of the Czech economy had slowed to 4% in 2015 Q4. This was 1.3 percentage points lower than the growth assumed by the forecast contained in the first situation report. The deviation had been due to significantly slower growth in gross capital formation, with growth in fixed investment and change in inventories both lagging behind the expectations of the forecast. The more modest growth of fixed investment was probably linked with earlier completion of public sector projects financed from EU funds, although private investment also recorded a decline. Annual gross value added growth had slowed to 3.8%. This growth had been driven mainly by manufacturing, although most other sectors of the economy had also made positive contributions. The continuing economic growth had also fostered an improvement in the labour market situation. The seasonally adjusted unemployment rate had fallen further in Q4 to 4.6%. The average wage had gone up by 3.9% in Q4, which was 0.4 percentage point less than expected by the forecast. Total employment and the number of employed persons had conversely risen at a higher pace than forecasted in 2015 Q4.

In the discussion that followed the presentation of the situation report, the board members assessed the effect of the newly available information on the risks to the current inflation forecast. The prevailing view was that the balance of risks to the current forecast was slightly anti-inflationary at the monetary policy horizon. However, the opinion was also expressed that the anti-inflationary risks to the forecast were stronger. There was a consensus that the appropriate response to the current situation was to leave monetary policy rates unchanged at technical zero and that a need to maintain easy monetary conditions persisted. In this context, the Board also discussed the likely timing of the discontinuation of the exchange rate commitment. A majority of the board members agreed that, based on the new information, the probable exit date had moved nearer to mid-2017. The Board’s earlier statement that it would not discontinue the use of the exchange rate as a monetary policy instrument before 2017 meanwhile remained valid.

In a discussion about domestic economic developments, there was a consensus that the economic growth could be regarded as robust and sustainable. It was said repeatedly that although observed average wage growth was lower than expected, employment growth was higher than expected, so the total wage bill was rising in line with the forecast. It was also mentioned that the median wage was rising faster than the average wage, which could stimulate faster growth in consumption than in the average wage due to the higher propensity to consume among low-income households. It was also said that retail sales were rising steadily and that growth in consumer credit would support household consumption going forward. It was mentioned several times that fiscal policy might be more relaxed in future years than assumed by the forecast and that this would imply an increase in domestic demand pressures. It was said repeatedly that the low level of headline inflation had been influenced by the continued fall in foreign producer prices and the decline in prices of food and oil, which were exogenous factors not linked with the cyclical position of the Czech economy. It was mentioned several times that monetary policy could, at a cost, overcome these factors as well, but that such action was not necessary at the moment. The board members agreed that the level of adjusted inflation excluding fuels, which in recent months had been constantly within the tolerance band around the headline inflation target and currently stood at 1.3%, testified to a resurgence of domestic demand pressures. At the same time, however, this level did not suggest any overheating of the economy at present. It was also said that the introduction of the exchange rate commitment in November 2013 had contributed to the generally positive evolution of the Czech economy.

In a discussion of the deviation of observed inflation from the forecast, it was repeatedly emphasised that the oil price decline in past years represented a positive supply shock. It was said several times that lower-than-expected food price inflation – due, among other things, to the abolition of milk production quotas in the EU and to good harvests throughout Europe – also represented a positive supply shock. It was said that food price inflation was a volatile component of the short-term inflation forecast. The board members agreed that the first-round effects of supply shocks, which, moreover, were coming mainly from abroad, should be exempted explicitly, as monetary policy was effective only in influencing domestic demand. It was said several times that in the absence of those foreign supply shocks, headline inflation would by now be in the tolerance band around the target. However, the opinion was also expressed that the recent decline in the oil price was no longer having a downward effect on inflation at the monetary policy horizon. It was said repeatedly that if anti-inflationary pressures materialised, the primary instrument for easing monetary conditions was to delay the exit from the exchange rate commitment. It was also said that in the event of stronger anti-inflationary pressures it was possible to consider moving the level of the commitment. It was said that other ways of easing monetary policy were associated with considerably greater risks and costs.

The Board also discussed the possibility of introducing negative interest rates. The prevailing view was that negative rates were not an appropriate tool for easing monetary conditions and hence for influencing inflation directly at the monetary policy horizon. However, it was said repeatedly that negative rates could be a useful tool if there were expectations or materialisation of appreciation pressures on the koruna due to the existing interest rate differential between the Czech Republic and the euro area. However, it was pointed out that such pressures had not been observed so far and negative rates would not be applied automatically even if they were to materialise. It was said that the form of the potential introduction of negative rates was important. Nevertheless the Board agreed that the CNB is not limited in the amount of foreign exchange reserves it can hold. It was said repeatedly in the discussion that the situation of sustained low interest rates and the potential introduction of negative rates were creating challenges to financial stability and that decisions on matters of financial stability could not be separated from those on monetary policy issues. However, the opinion was expressed that any slight reduction of banks’ margins due to the potential introduction of negative rates would not represent a major problem for financial stability, as the situation of the banking system in the Czech Republic was very good.

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: Tomáš Havránek, Adviser to the Board