By Jana Mlcochova and Michael Winfrey (Reuters 16.5.2012)
PRAGUE, May 16 (Reuters) - Failing to cut Czech interest rates now could oblige the central bank to make a bigger move later, although weakening in the crown currency could reduce the pressure on policymakers to act, Czech central bank governor Miroslav Singer said.
At the bank's last rate meeting on May 3, Singer voted in a minority of two to cut the bank's benchmark rate, now at a record low 0.75 percent, to 0.50 percent. The seven-member board paused its easing cycle two years ago.
Since the meeting, economists have said more news has emerged to strengthen arguments for looser policy, including preliminary first quarter growth data showing the central European country of 10.5 million had headed deeper than expected into recession.
"A decline in interest rates is something that in my opinion corresponds with the situation in which we are. We frankly do not see any upward inflationary pressures from domestic demand ... On the monetary policy horizon, we see inflation below target," Singer told Reuters in an interview.
"I simply do not see the value of further waiting. And of course any procrastination may make us start thinking next time, or later, of an even more pronounced response."
However, Singer pointed out that possible crown weakening in the future could help mitigate pressure for easing.
"We need to follow the total effect of the exchange rate and the interest rate, meaning if the exchange rate is weaker we may not need to cut that much," he said.
The crown hit a fresh four-month low 25.760 on Wednesday. It lost as much as 3.2 percent this month mainly on worries over a possible Greek exit from the euro zone.
But Singer said the recent weakening in the exchange rate was "not extreme volatility". He added: "If I had known two weeks ago what would have happened until today, I would have most likely voted the same way" at the May 3 rate meeting.
EASING PRESSURE BUILDS
According to analysts and market players who took part in a recent policy presentation at the bank, the board's baseline scenario implies cuts in the two-week repo rate worth half a percentage point in the coming months.
An alternate scenario sees three quarters of a point in cuts, which would bring the repo rate to zero.
Despite a long trend of negative underlying core inflation, the central bank has refrained from cuts due to what analysts say is limited room with rates already at a quarter point discount to the euro zone.
But that taboo began to crack this month when, following a proposed government austerity package that the central bank predicted could cut its 2013 growth forecast almost in half to 1.1 percent, Singer voted for a cut along with Vice Governor Vladimir Tomsik.
Four of the board's other members voted to keep rates flat and policy hawk Eva Zamrazilova voted for a quarter point hike.
Now other factors, including data showing the economy had shrunk 1 percent from January to March versus the previous quarter, could swing other votes towards easing.
Singer's other deputy, Mojmir Hampl, said after the data that it would be "much harder to think about anything else in the future other than further easing".
Singer said it was hard to draw strong conclusions from the preliminary data, but he said his personal view that the Czech economy could grow a touch this year - rather than the bank's official forecast for stagnation - may have been too rosy.
"The whole set of data released in the past two weeks corresponds to my gut feeling the economy is going to face a slowdown even in sectors in which we have been doing well so far," he said.
Singer said the biggest risk of a deepening of the Greek crisis for the Czechs would be its effect on the crown currency.
However, if trouble with Greece hit Europe as a whole, it could also have a balancing, deflationary effect by squeezing foreign demand for Czech exports.
"We would probably see a faster deleveraging of financial systems in countries to which we export and that may offset any inflationary pressure coming from a weaker exchange rate.
"It would make the adjustment of the (weaker) exchange rate more acceptable."
ON MAY RATE DECISION
"A decline in interest rates is something that, in my opinion, corresponds with the situation in which we are. We frankly do not see any upward inflationary pressures from domestic demand.
"The effects coming from tax changes are to evaporate on the policy horizon.
"For me this is a situation, despite the fact that rates are already very low, when we should simply consider doing what is a traditional response to such a situation.
"On the monetary policy horizon we see inflation below target. That is something that may require some adjustment of interest rates.
"For me it was relatively clear (at the last meeting). And we've been moving towards that area as we have had alternative scenarios hinting to a deeper decrease in interest rates. These alternatives, in a sense, at times became a baseline scenario.
"I do not see any big change on the horizon that would alter something fundamental about the outlook of a very high uncertainty in the European economic situation.
"That uncertainty is being transferred to investors' hesitation and consumers' hesitation."
ON IMPACT OF POTENTIAL CUT
"Of course, it is more difficult to go further down when you are already so close to zero.
"But if you read the forecast, if you consider what is happening, it seems to me that by not reacting we are simply risking undershooting the inflation target.
"I simply do not see the value of further waiting.
"And of course any procrastination may make us start thinking next time, or later, of an even more pronounced response.
"I will decide how I am going to vote next time shortly before the next meeting. That's the only way I work."
ON RATES AND FX
"Expectations of agents in the economy are pushing towards a weaker exchange rate. That can be a factor in everybody's decision making on setting interest rates, including mine.
"I view the exchange rate and the interest rate as a sort of pair in my decision making, and I need to consider them both.
"In this respect I am not sure whether we will exactly follow the path of the forecast. We need to follow the total effect of the exchange rate and the interest rate, meaning if the exchange rate is weaker we may not need to cut that much.
"It is not about the way the exchange rate is going to (go) next week. It is about what the exchange rate may do in the next half a year at least.
"If I had known two weeks ago what will happen until today, I would have most likely voted the same way."
ON ALTERNATIVE POLICY TOOLS, FX
"We definitely prefer playing with normal policy tools. We do not need to consider alternative tools from the point of view of financial stability because we do not have a problem in this area. It makes alternative policy tools even less appetizing for us.
"We still have a 0.75 percent rate so we can change it up and down.
"So far, we have been in a situation that we do not have to consider that much more than simply changing rates.
"In the past we were considering other channels especially in a situation of an abrupt change of exchange rate. But that is not what we are seeing now."
ON GROWTH
"I am not drawing any strong conclusions from the first quarter GDP. It sort of fits in the picture but it was influenced by one-off factors and it is preliminary data.
"The whole set of data released in the past two week corresponds to my gut feeling the economy is going to face a slowdown even in sectors in which we have been doing well so far.
"On the other hand, the anecdotal evidence I get from entrepreneurs that I know is a bit different, more optimistic.
"I have been so far more optimistic. I have been expecting growth above zero this year. On industrial side I feel relatively healthy activities anecdotally.
"The first quarter data means in next three quarters the numbers would have to be higher or this estimate would have to be corrected for this optimism to become reality."
FISCAL ISSUES
"I will not comment on a particular fiscal policy of a particular government.
"I believe that each government here must ask itself how much it wants to risk lower growth and related lower budget revenues versus higher interest on its debt and related expenses on interest rates."
ON GREECE
"The exchange rate channel is the only channel that may hurt us with escalation of problems with Greece. Although the hurting is a very relative term.
"We would probably see a faster deleveraging of financial systems in countries to which we export and that may offset any inflationary pressure coming from a weaker exchange rate. It would make the adjustment of the exchange rate more acceptable.
"A situation in which there is a faster deleveraging of the European financial sector is definitely going (to have)deflationary consequences for us via fall of real demand for our exports.
"If Greece is a trigger of this, the pro-inflationary effects of the weaker exchange rate will be very likely balanced by lower demand for our exports, which is an anti-inflationary effect.
"The ratio is about 60:40, I can imagine a scenario in which anti-inflationary and demand shocks are even bigger than exchange rate shocks. I am not saying this is more likely, but it is possible."
ON LATEST FX MOVES
"Those are the moves that may influence my thinking how the future is going to deviate from the forecast and may therefore influence my thinking of interest rates.
"But those are not the moves that I would be surprised with. This is a normal deviation from the forecast. This is not extreme volatility. This is volatility; we have seen such volatility many times before."
COMPARISON WITH CRISIS IN EARLY 2008
"The private part of the financial system is insulated in a much better way from the Greek crisis as a result of postponement of its acceleration.
"Markets know what the basic data are. Nobody is going to be shocked by how much this and that country's banking system may hold in Greek assets. The situation is more transparent and better.
"Communication is now going to be easier than in 2008. At that time we realized how a good communication tool a future interest rate and exchange rate path announcement is.
"I feel it's clear for markets that the situation here is different from the situation in some other new European economies. This is also reflected in yields and CDS."