Minutes of the Bank Board Meeting on 5 May 2016

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

The meeting opened with a presentation of the third situation report and the new macroeconomic forecast covering the horizon up to the end of 2017. Domestic inflation had increased slightly in 2016 Q1, but remained well below the 2% target. The slightly positive inflation had been due to the return of administered prices to annual growth and to still markedly positive adjusted inflation excluding fuels. This indicator reflected the positive effect of growth in the domestic economy and wages. By contrast, prices of food and fuels had declined as a result of persisting anti-inflationary supply shocks from abroad. Annual real GDP growth had slowed to 4% in 2015 Q4. Economic activity had been supported by easy monetary conditions, a marked increase 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 mid-2017. This was one of the factors helping inflation to return to the target in the first half of next year in the forecast. Consistent with the forecast was an increase in market interest rates in the second half of 2017. According to the forecast, 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 assumed that headline inflation would decline temporarily close to zero in the near future owing to a renewed decrease in administered prices, a deepening of the decline in food prices and a temporary slowdown in adjusted inflation. At the close of this year, however, inflation would start to increase, hitting the target at the monetary policy horizon, i.e. in 2017 Q2 and Q3, and then slightly exceeding it. The growth of the Czech economy would slow to 2.3% this year from the exceptionally high level recorded last year. This would be due mainly to a fall in government investment as a result of an only gradual start to the drawdown of EU funds in the new programme period. On the other hand, economic growth would continue to be supported by easy domestic monetary conditions, low oil prices and rising external demand. After the fall in government investment faded out, GDP growth would accelerate to over 3% next year. The rising economic activity would manifest itself in continued growth in employment and a modest decrease in unemployment. Wages would rise at a steady pace this year and accelerate further next year.

In the discussion that followed the presentation of the situation report, the Board assessed the risks to the new forecast as being slightly anti-inflationary. Producer price inflation in the euro area, which may be more subdued than currently assumed, was a risk. The board members also expressed their agreement with the overall message of the forecast. There was a consensus that it was appropriate to leave monetary policy rates unchanged at technical zero and that a need to maintain easy monetary conditions persisted. In this situation, the Board discussed the timing of the likely discontinuation of the exchange rate commitment. The board members agreed that it would probably be discontinued in mid-2017, in line with the forecast. All the Board’s earlier statements that it would not discontinue the use of the exchange rate as a monetary policy instrument before 2017 meanwhile remained valid.

It was said several times that the risk of undesirable second-round effects of foreign cost factors was rising as the duration of the period of very low inflation increased, although those factors primarily represented favourable supply shocks. It was pointed out repeatedly that monetary policy reacts to these adverse second-round effects of positive cost factors, unlike to their first-round price effects. In this regard, a majority of the board members expressed a readiness to shift the exchange rate commitment to a weaker level if there were to be a systematic decrease in inflation expectations manifesting itself in nominal variables, especially wages. One board member stated that the likelihood of such a step had increased.

In connection with the need to maintain easy monetary conditions, the Board also discussed the possibility of introducing negative interest rates. The prevailing view was that negative rates were not an appropriate tool for additionally easing monetary conditions and hence for influencing inflation directly at the monetary policy horizon, although negative interest rates could serve effectively as a tool for defending the exchange rate commitment. However, the opinion was expressed that negative interest rates could be an appropriate complementary tool if the level of the exchange rate commitment were to be moved.

Real convergence was repeatedly evaluated. It was said several times that the rate of real convergence might be weaker than in the pre-crisis period, but a majority of the Board agreed that the real convergence trend remained indisputable. It was said repeatedly that in the exchange rate commitment environment, real convergence was automatically contributing to easing the monetary conditions. This meant among other things that the domestic price level was adjusting to the nominal level of the exchange rate commitment and hence that the exchange rate would not appreciate sharply following the discontinuation of the exchange rate commitment. It was said that even if the exchange rate commitment level were to be moved, the domestic price level would first have to increase to a level that would prevent sharp appreciation of the koruna. It was also said that the pass-through to the price level of any shift of the exchange rate commitment level would probably be faster at present than when the exchange rate commitment was introduced in 2013, because the cyclical position of the Czech economy was currently much more favourable. There was a consensus that the introduction of the exchange rate commitment in November 2013 had been one of the factors that had contributed to the current favourable cyclical position of the Czech economy.

The Board assessed the labour market situation primarily with regard to nominal wage growth, which had been lower than assumed by the previous forecast. It was said repeatedly that unemployment had fallen to its equilibrium level and that this decline would necessarily be reflected in the future in nominal wage growth, which was helping inflation to return to the target at the monetary policy horizon. In this context, it was also mentioned that structural changes had occurred in the labour market during the crisis and that those changes might temporarily postpone wage growth. However, the effect of the changes was disappearing as the economic recovery progressed and it was therefore highly likely that nominal wage growth consistent with hitting the inflation target would be renewed. Given that fact, it was not necessary to move the level of the exchange rate commitment at the moment. On the other hand, it was argued that the number of firms in industry which perceive labour shortages as a barrier to growth was low and that this was reducing the pressure for future wage growth.

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: Jan Brůha, Adviser to the Board