Minutes of the Bank Board Meeting on 4 August 2016

Present at the meeting: Jiří Rusnok, Mojmír Hampl, Vladimír Tomšík, Vojtěch Benda, Lubomír Lízal, Tomáš Nidetzký, Pavel Řežábek.

The meeting opened with a presentation of the fifth situation report and the new macroeconomic forecast covering the horizon up to the end of 2018. Domestic inflation had been 0.3% on average in 2016 Q2, 0.2 percentage point lower than in Q1. It was thus still well below the CNB’s 2% target. This low inflation was still being caused by positive supply-side shocks from abroad. These shocks were reflected in a renewed decline in food prices and administered prices as well as a drop in fuel prices, which had, however, now started to moderate. By contrast, adjusted inflation excluding fuels remained markedly positive. This indicator reflected the positive effect of growth in the domestic economy and wages. The growth of the Czech economy had slowed to 3% in 2016 Q1, mainly because of subsiding growth in government investment financed by EU funds from the previous programme period. Steadily rising household consumption had been the biggest contributor to annual GDP growth. The economy continued to be supported by still easy monetary conditions, low commodity prices and rising external demand.

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. Consistent with the forecast was an increase in market interest rates thereafter. 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. According to the forecast, inflation would start rising in the near future, driven by increasing domestic economic activity and wages. At the same time, the already fading anti-inflationary effect of import prices would gradually disappear. Inflation would slightly exceed the 2% target at the monetary policy horizon, i.e. in 2017 Q3 and Q4, and then return to the target from above. According to the new forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, would thus occur in mid-2017. The growth of the Czech economy would slow further in the course of this year because of a temporary decline in gross capital formation due mainly to a fall in government investment co-financed from EU funds. After the drop in government investment unwound, economic growth would pick up to 3% next year amid still robust household consumption. The economy would then grow at the same pace in 2018. The rising economic activity would manifest itself in continued growth in employment, although its pace would slow. This would result in a further, albeit only modest, decrease in the unemployment rate. Wage growth would accelerate further in both the business and non-business sectors.

In the discussion that followed the presentation of the situation report, the board members agreed that the risks to the new forecast were balanced. The evolution of external demand, the effect of the domestic election cycle on public expenditure growth, the depth of the fall in government investment this year and the impact of the long-lasting low inflation on the anchoring of inflation expectations were identified as the main uncertainties. The board members also agreed with the overall message of the forecast. A need to maintain expansionary monetary conditions at least to the current extent therefore persisted. There was a consensus that the appropriate response was to leave monetary policy rates unchanged at technical zero. The Board stated again that the CNB would not discontinue the use of the exchange rate as a monetary policy instrument before 2017. The Board still considered it likely that the commitment would be discontinued in mid-2017. The Board also still stood 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.

It was said repeatedly that newly published data confirmed the positive tendencies in the domestic economy and that the new forecast was more optimistic than the previous one in terms of fulfilling the monetary policy mandate, i.e. hitting the inflation target. It was said repeatedly that the positive supply shocks from abroad, which were causing the current low inflation, would gradually subside. However, it was said that any further deepening of the decline in import prices would represent an additional downside risk to inflation because of the potential pass-through of the undesirable second-round effects to domestic inflation. It was said several times that at the monetary policy horizon, i.e. in the second half of 2017, the forecast was expecting sustainable fulfilment of the inflation target, which is a condition for exiting the exchange rate commitment. Some of the board members argued that a similar inflation scenario had been discussed in 2013. Back then, this scenario had called for an easing of monetary conditions in the form of the introduction of the exchange rate commitment, whereas now there was no need to alter the monetary policy settings. This indicated that the monetary conditions were sufficiently easy.

The Board discussed the outlook for domestic economic growth and its implications for the inflation forecast. It was said that the temporary fall in growth this year was not surprising and was due to factors beyond the reach of monetary policy, most notably a drop in government investment. However, attention was drawn to low corporate investment and to some less favourable business indicators in industry. It was said in this context that firms had probably previously been investing in capacity, which was currently sufficient to meet demand. It was said repeatedly that industrial production in the Czech Republic and in its main trading partner countries was rising, as were new orders and loans to non-financial corporations. It was said that the positive condition of the economy was also indicated by better-than-expected performance of the revenue side of the state budget. It was said in the discussion that the economy – aided by easy monetary policy – was on a robust growth path and that this growth would mean a return of inflation to the target at the forecast horizon. It was said several times that the configuration of the monetary conditions was affecting financial stability and that this was being reflected, for example, in growth in loans and debt. The situation was being monitored and addressed with macroprudential policy tools. Support was also expressed for further analytical studies at the CNB in areas on the dividing line between monetary and macroprudential policy.

In a discussion about the labour market, it was said repeatedly that the forecast’s assumption of faster wage growth was correct thanks to positive tendencies in the labour market. In this regard, attention was drawn to the figures on rising employment, which was now exhausting the available labour sources. It was also said that wage bargaining for next year in an environment of rapid economic growth would be a favourable wage growth factor. It was said that the higher wages would feed through to inflation not only via higher demand, but also more directly through the very expectation of faster wage growth.

The opinion was expressed that domestic inflation was being affected by the global disinflationary environment and that the risks arising from abroad were hard to quantify given the current uncertainties. It was said that the UK’s likely future exit from the EU would probably have a larger impact on the financial sector than on the real economy and that the domestic financial sector was sufficiently resilient to such effects. Some of the board members pointed to the risks arising from the published stress tests of European banks. The view was repeatedly expressed that any prolongation of accommodative monetary policy in the euro area was a greater risk from abroad for the domestic economy. It was also said several times in the discussion that developments in the domestic economy were of primary importance for sustainable fulfilment of the inflation target and that the domestic economy was generating sufficient inflation pressures to return inflation to the target.

At the close of the meeting the Board decided unanimously to leave the two-week repo rate unchanged at 0.05%. Jiří Rusnok, Mojmír Hampl, Vladimír Tomšík, Vojtěch Benda, Lubomír Lízal, Tomáš Nidetzký 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: Kamil Galuščák, Executive Director, Economic Research Department