Minutes of the Bank Board Meeting on 3 November 2016
Present at the meeting: Jiří Rusnok, Mojmír Hampl (present only at the discussion that followed the presentation of the situation report), Vladimír Tomšík, Vojtěch Benda, Lubomír Lízal, Tomáš Nidetzký, Pavel Řežábek.
The meeting opened with a presentation of the seventh situation report and the new macroeconomic forecast covering the horizon up to the end of 2018. Domestic inflation had increased slightly to 0.5% on average in 2016 Q3. It was thus still well below the CNB’s 2% target, or below the lower boundary of the tolerance band around the target. The main source of growth in consumer prices was adjusted inflation excluding fuels, which had risen at a pace of 1.1%, reflecting growth in the domestic economy and wages. The low headline inflation was still due to positive supply-side shocks from abroad and a resulting decline in food and fuel prices. However, the impact of those shocks was gradually fading. Czech GDP growth had slowed further to 2.6% in 2016 Q2, mainly because of a decline in government and private investment co-financed from EU funds, and had thus been driven by net exports. The economy continued to be supported by easy domestic monetary conditions via the weakened exchange rate of the koruna and exceptionally low interest rates. Low oil prices and rising external demand were also contributing favourably to economic growth.
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. 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 increase further and slightly exceed the 2% target at the monetary policy horizon. During 2018, it would return to the target from above. The increase in inflation would reflect rising wages and price of capital amid continued growth in economic activity combined with gradually fading anti-inflationary cost factors from abroad. According to the new forecast, sustainable fulfilment of the target, which is a condition for a return to conventional monetary policy, would occur from mid-2017 onwards. After slowing this year, the Czech economy would maintain a similar pace of growth in the next two years. Renewed growth in investment would foster higher economic growth. By contrast, growth of the domestic economy would be hindered by a temporary slowdown in external demand, linked, among other things, with the impacts of the result of the UK referendum on economic sentiment, and later also by less easy monetary conditions following the discontinuation of the CNB’s exchange rate commitment. The growing economic activity would be reflected in an increase in wage growth. The unemployment rate would decrease only slightly.
In the discussion that followed the presentation of the situation report, the board members agreed that the risks to the new inflation forecast at the monetary policy horizon were balanced. The speed of return to growth in government and corporate investment, the effect of the election cycle on discretionary government expenditure, the impacts of the outcome of the UK referendum and the future settings of the monetary conditions of the major central banks were identified as the main uncertainties of the forecast. The board members also agreed with the overall message of the new forecast. A need to maintain expansionary monetary conditions at least to the current extent persisted. The Board therefore stated that the Czech National Bank would not discontinue the use of the exchange rate as a monetary policy instrument before 2017 Q2. The Board still considered it likely that the commitment would be discontinued in mid-2017. In line with the exchange rate commitment, the CNB still stood ready to intervene automatically without any time or volume limits.
The board members agreed that macroeconomic developments in the last quarter had essentially confirmed the predictions of the previous forecast, as the external inflation pressures and the decline in commodity prices were both gradually fading. It was said repeatedly that the growth of the domestic economy was fairly robust, as it was distributed evenly between domestic and external demand. A number of the board members nevertheless expressed doubts about the resumption of investment growth in 2016 H2 assumed in the forecast. In this regard, the reasons for the deeper-than-expected decline in investment in the non-financial corporations sector in 2016 Q2 were discussed. The prevailing view was that the buoyant growth in investment by non-financial corporations recorded in 2015 had been due predominantly to investment co-financed from EU funds, and that one of the main reasons for the present decline in such investment was the only gradual start to the drawdown of European funds at the beginning of this year and the related base effect. The fact that private investment can be conditional on public money was identified by some of the board members as an unsound structural factor for the Czech economy. Mention was also made of the hypothesis that given the high import intensity of most private investment, the data may reflect deferral of investment due to expectations of a lower exchange rate and lower investment costs. Against this, however, it was argued that such deferral of investment was not rational from the perspective of firms, because they can hedge against such exchange rate movements by, for example, taking out foreign currency loans. Some of the board members also commented on the decline in private investment in connection with the shift of the labour market towards full employment. It was said that in this situation, capital should conversely substitute for labour and that the current trend represented a risk to the economic convergence of the Czech economy. Overall, the Board agreed that subdued private sector investment could represent an anti-inflationary risk to the forecast going forward.
With regard to the interpretation of domestic economic developments, the Board also discussed other components of demand. Some of the board members commented on the fiscal policy stance in the light of the latest government budget data. The risk that fiscal policy would be restrictive this year, and not expansionary as assumed by the forecast, was mentioned. The effect of the easy interest rate component of the monetary conditions on the high observed growth in loans to households was also discussed. The risk that repayment of those loans could in the future affect the gross saving rate and thus depress private consumption was mentioned. Against this, however, it was said that analyses such as the Lorenz curve indicated that new loans were concentrated among high-income households and that this would cushion the impacts of loan repayment on aggregate consumption. The shape of the Lorenz curve, and the fact that loans were being provided primarily to people with higher incomes, suggested that banks were still lending prudently and was thus a positive factor as regards financial stability.
The Board also discussed the risks and uncertainties stemming from developments abroad. It was said repeatedly that the biggest external uncertainties for the domestic economy were the potential prolongation of easy monetary policy in the euro area and the uncertainty surrounding the return of euro area inflation to the target. The board members agreed that there was significant uncertainty associated with the parameters of the potential prolongation of quantitative easing by the ECB. Moreover, its impacts on the domestic economy were not entirely clear, as there could be a rise in external inflation in parallel with increased downward pressures on domestic interest rates and appreciation pressures on the koruna. The impact of the elections in the USA and its effect on US interest rates and the euro-dollar exchange rate were also mentioned as external uncertainties. The opinion was also expressed that recent developments around OPEC could represent an anti-inflationary risk to the materialisation of the oil and fuel price growth outlooks. The board members agreed that the risks stemming from abroad were hard to quantify given the current uncertainties.
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, 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: Michal Hlaváček, Adviser to the Board