Minutes of the Bank Board Meeting on 29 September 2016

Present at the meeting: Jiří Rusnok, Vladimír Tomšík, Lubomír Lízal, Tomáš Nidetzký.

The meeting opened with a presentation of the sixth situation report assessing the new information and its effect on the fulfilment of the forecast contained in the fifth situation report. The 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. In line with the forecast, annual headline inflation had risen to 0.5% in July and 0.6% in August, rebounding from levels close to zero. This had been due mainly to food prices, which had returned to year-on-year growth. The annual decline in fuel prices had moderated somewhat, but remained in double figures and was contributing to the generally low inflation. By contrast, core inflation (adjusted inflation excluding fuels) remained markedly positive and reflected the favourable effect of growth in the domestic economy and wages.

As expected, annual growth in the Czech economy had slowed in 2016 Q2; the rate of growth had been 2.6%. In line with the forecast, the slowdown in economic growth had been due to a marked fall in fixed investment as a result of an only gradual start to the drawdown of EU funds in the new programme period. However, the slowdown in economic growth had been smaller than forecasted, mainly because of a lower-than-expected decrease in inventories and higher growth in net exports. As in Q1, annual growth in gross value added had been 2.7%, as the dynamics of gross value added in construction had turned negative, but industry and services had recorded stronger growth rates. The continuing domestic economic growth had also fostered a further improvement in the labour market situation. The seasonally adjusted unemployment rate had fallen slightly further. The average wage had risen by 3.9% year on year in Q2, and was therefore 0.3 percentage point lower than forecasted. Growth in both total employment and the number of employees had continued broadly in line with the forecast in Q2.

In the discussion that followed the presentation of the situation report, the Board assessed the effect of the newly available information on the risks to the current inflation forecast. There was a consensus that the risks to the forecast were balanced at the monetary policy horizon. The board members agreed that the forecast had materialised in almost all its parameters and that the appropriate response to the current situation was to leave monetary policy rates unchanged at technical zero. A need to maintain expansionary monetary conditions persisted. The Board also stated that the Czech National Bank would not discontinue the use of the exchange rate commitment as a monetary policy instrument before 2017 Q2. The board members still considered it likely that the commitment would be discontinued in mid-2017. At the same time, the 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.

The Board discussed 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. The economy had grown at an exceptionally strong pace in 2015 not only as a result of increased drawdown of EU funds at the close of the programme period, but also on account of a positive income effect stemming from the fall in the prices of oil and other commodities. It was said that core inflation was still developing favourably, moving at the boundary of the tolerance band around the target. It was mentioned repeatedly that the lower-than-forecasted growth in household consumption in Q2 had not been based on fundamental factors. It had probably been a statistical artefact due to the effect of working day adjustment, which had been significant in Q2. However, it was also said that even consumption unadjusted for the number of working days was rising more slowly than the wage bill, and therefore developments in savings and real estate investment had to be monitored, among other things with regard to their potential effects on financial stability. The Board agreed that the dynamics of consumption represented an uncertainty of the forecast.

In a discussion about economic developments abroad, the Board stated that the monetary policies of the ECB and other major central banks were only one of the factors affecting the CNB’s steps, albeit an important one. It was said repeatedly that domestic factors were of key importance, in particular growth in wages and consumption, which was feeding through to inflation. However, it was also mentioned that the stance of the ECB’s monetary policy next year could have an impact on the timing of the discontinuation of the exchange rate commitment. The board members agreed that the new situation report contained no major changes regarding the evolution of the relevant foreign economies, but a number of uncertainties existed in this respect, especially in connection with European countries.

The Board discussed the existing commitment that the CNB would not discontinue the use of the exchange rate as a monetary policy instrument before the start of 2017. The prevailing view was that extending the commitment by one quarter was now appropriate, as it would reduce uncertainty in the economy for the next several months. The newly available data did not change the Board’s view that the use of the exchange rate would probably be discontinued in mid-2017, and it could therefore be ruled out that this step would need to be taken already in 2017 Q1. It was said repeatedly that the CNB preferred rules over discretion and that the information about the timing of the discontinuation of the use of the exchange rate as a monetary policy instrument published in the current forecast reflected the Board’s expectations.

The Board also discussed the potential use of negative interest rates. There was a consensus that the introduction of negative monetary policy interest rates as a tool to support the exchange rate commitment or a smooth exit from the commitment could not be ruled out. The board members also agreed that some financial market segments were already operating at interest rates relatively deep in the negative territory, which were originating spontaneously in the market and were helping to discourage speculative capital. It was said that under these conditions the need to use statutory negative rates was currently decreasing. It was mentioned repeatedly that domestic exporters would hedge before the expiry of the commitment and that the CNB stood ready to intervene so as to cover demand for the koruna generated by domestic economic growth.

At the close of the meeting the Board decided unanimously to leave the two-week repo rate unchanged at 0.05%. Jiří Rusnok, Vladimír Tomšík, Lubomír Lízal and Tomáš Nidetzký 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 against the euro close to CZK 27/EUR.

Author of the minutes: Tomáš Havránek, Adviser to the Board