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 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 CNB 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 based on the message of the current forecast and on an assessment of newly available information obtained since the current forecast was prepared. 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 mid-2017. Inflation is still well below the CNB’s target of 2%. In line with the forecast, inflation has declined temporarily close to zero. This reflects the fact that domestic inflation is still being affected by strong anti-inflationary effects from abroad. Monetary policy looks past the first-round effects of such factors and focuses on any adverse second-round effects. Inflation will remain close to zero in 2016 Q3. However, it will then increase, hitting the 2% target at the monetary policy horizon. According to the current forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will occur from mid-2017. The Bank Board assessed the risks to the current forecast at the monetary policy horizon as being slightly anti-inflationary.
A need to maintain expansionary monetary conditions at least to the current extent persists. The Bank Board therefore states again that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017. The CNB continues to stand ready 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. At the same time, the Bank Board stated again 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 line with the forecast, annual headline inflation fell to 0.1% in May. The individual components of inflation also developed as expected. The increase in consumer prices was due solely to adjusted inflation excluding fuels, reflecting growth in the domestic economy and wages. By contrast, the contributions of all other components of inflation were negative, owing to anti-inflationary cost effects mainly from abroad. Administered prices started to decline year on year as a result of lower prices of natural gas for households, and food prices also returned to a year-on-year decrease.
As expected, annual growth in the Czech economy slowed in 2016 Q1. However, the growth rate of 3% was slightly higher than forecasted. In line with the forecast, the slowdown in economic growth was due to a marked fall in the contribution of fixed investment as a result of an only gradual start to the drawdown of EU funds in the new programme period. The slightly stronger increase in economic activity compared to the forecast was aided by a higher contribution of inventories and household consumption, which was only partly offset by a lower contribution of net exports.
Information on economic developments abroad obtained from the June Consensus Forecasts suggests that economic activity in the effective euro area will continue to rise at a relatively stable pace of around 2%, still supported by easy monetary conditions and low oil prices. The forecast for euro area producer prices was revised downwards for this year, so the unwinding of their decline shifted to the beginning of next year. The consumer price inflation outlook for this year was also lowered marginally. The market outlook for the 3M Euribor was virtually unchanged. Foreign interest rates will thus remain slightly negative over the entire forecast horizon.
The mid-June market outlook for Brent crude oil prices increased amid rising demand on account of previous unexpected extraction shortfalls, up by around USD 5 a barrel over the entire horizon. Only two weeks ago, Brent crude oil prices were thus expected to rise to USD 55 a barrel by the end of next year. At the same time, the June outlook for the euro-dollar exchange rate shifted towards a slightly stronger euro owing to expectations of a more gradual monetary policy tightening in the USA. However, the result of the referendum on the exit of the UK from the EU then caused a depreciation of the euro against the dollar.
The continuing domestic economic growth is fostering a further improvement in the Czech labour market situation. Growth in both total employment and the number of employees picked up pace in 2016 Q1, standing above the current forecast. Ongoing growth in labour demand was reflected in a further drop in the seasonally adjusted unemployment rate. The seasonally adjusted share of unemployed persons also continued to decrease. Annual wage growth in the business sector accelerated to 4.5%, and was therefore slightly above the forecast. Wage growth in the non-business sector was also slightly higher than forecasted. The wage median increased at a faster year-on-year pace than the average wage, reflecting strong wage growth mainly for lower-income employees.
Indicators from the real economy point to continued economic growth in 2016 Q2. Growth in retail sales remains strong. Industrial production is still rising moderately, while the year-on-year decline in construction output has been deepening gradually since January 2016. This is in line with the downturn in government sector investment activity this year in connection with the EU funds drawdown cycle.
The year-on-year decrease in prices in manufacturing and agricultural producer prices has deepened further so far in 2016, reflecting above all anti-inflationary cost effects from abroad. Prices of market services were broadly flat year on year, whereas construction work prices continued to rise moderately.
To sum up the important facts about recent developments in the Czech economy, both GDP and the average wage increased slightly faster in 2016 Q1 than forecasted. By contrast, inflation in May and unemployment so far in Q2 were in line with the CNB’s forecast.
The Bank Board assessed the risks to the forecast at the monetary policy horizon as being slightly anti-inflationary. The risk of more subdued industrial producer prices in the euro area persists. The same is true for the risk of long-standing low inflation passing through to inflation expectations and wage developments. However, the fact that wage growth was slightly above the current forecast in 2016 Q1 is an inflationary risk. The result of the referendum in the UK, which implies its likely future exit from the EU, is a new uncertainty. The reactions of the financial and commodity markets and negative impacts on economic sentiment in Europe, the strength of which is difficult to predict, will mainly play a role in the shorter term. In the context of the slightly anti-inflationary balance of risks to the current forecast, the Bank Board points out that the CNB stands ready 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. At the same time, the Bank Board states again that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017, i.e. in line with the assumption of the current forecast.
At the close of the meeting, the Bank Board thanked its two departing members, i.e. Governor Miroslav Singer and Chief Executive Director Kamil Janáček.