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. It confirmed the CNB’s commitment to intervene on the foreign exchange market if needed to weaken the koruna against the euro 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 without any time or volume limits. The asymmetric nature of this exchange rate commitment is unchanged.
This decision is based on the message of the August forecast and on an assessment of newly available information obtained since the 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 starting to rise in line with the forecast, but it is still well below the CNB’s target of 2%. Inflation is still being affected by anti-inflationary cost effects from abroad. Monetary policy looks past the first-round effects of such factors and focuses on any adverse second-round effects. According to the forecast, inflation will slightly exceed the 2% target at the monetary policy horizon and then return to it from above. According to the current forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, will occur in mid-2017.
A need to maintain expansionary monetary conditions at least to the current extent persists. The Bank Board therefore states that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017 Q2. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017. 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, as well as by the closing of koruna positions by financial investors. In addition, the CNB will stand ready to intervene to mitigate exchange rate volatility.
Headline inflation increased in line with the forecast in July and August, rebounding from levels close to zero. This was due mainly to food prices, which returned to year-on-year growth. Core inflation (adjusted inflation excluding fuels) remains markedly positive. It reflects the positive effect of growth in the domestic economy and wages.
The growth of the Czech economy slowed in 2016 Q2, albeit less significantly than forecasted. The higher-than-expected growth was due to additions to inventories and net exports. By contrast, fixed investment declined more markedly than forecasted.
The latest information on economic developments abroad largely confirms the assumptions of the current forecast. Economic growth in the effective euro area will temporarily slow below 2% next year. Producer prices in the Czech Republic’s main trading partner countries are expected to return to growth in 2017. Consumer price inflation in the euro area will also start to increase. This will also be fostered by the ECB’s continuing easy monetary policy, which is reflected in an outlook for slightly negative three-month Euribor rates over the entire forecast horizon.
The market outlook still expects the Brent crude oil price to rise gradually. The current outlook for the euro-dollar exchange rate is also broadly in line with the assumptions of the current forecast.
The rising domestic economic activity is manifesting itself in continued rapid growth in employment. This is reflected in a further drop in the seasonally adjusted unemployment rate. Annual wage growth in the business sector remains close to 4%, although it moderated somewhat in Q2.
Indicators from the real economy point to a continuing slowdown in economic growth in 2016 Q3. Industrial production saw a marked year-on-year fall in July, but this was largely due to one-off factors. The long-running decline in construction output, which mainly reflects a drop in public investment, deepened slightly further. By contrast, retail sales maintained solid growth.
The year-on-year price decline in manufacturing has moderated in recent months, whereas agricultural producer prices are still falling sharply. Prices of market services are broadly stable year on year, whereas construction work prices continue to rise moderately.
To sum up the important facts about recent developments in the Czech economy, GDP growth was slightly above the forecast in 2016 Q2, while average wage growth was somewhat lower than forecasted. Inflation and unemployment so far in Q3 were in line with the forecast.
Taking into account all the newly available information, the Bank Board assessed the risks to the current forecast at the monetary policy horizon as being balanced.