By Peter Laca (Bloomberg, 16.8.2012)
The Czech central bank delaying a cut in record-low interest rates may be forced in the future to adopt more radical policy-easing measures to avert deflation risks, Vice Governor Vladimir Tomsik said.
Czech policy makers were split at their last meeting on Aug. 2 in assessing inflation risks. Tomsik was one of two rate setters seeking a quarter-point reduction after the bank cut its two-week benchmark to a record 0.5 percent in June. Four board members took a wait-and-see stance even as the bank’s new forecast saw lower rates amid a worsening economic outlook.
“The forecast already assumes lower interest rates in the next several quarters,” Tomsik said in an interview at the Czech National Bank’s headquarters in Prague yesterday. “It’s still possible to make up for this delay, but the wait-and-see approach means running the risk of applying sharper steps.”
European Central Bank President Mario Draghi, whose main rate is a quarter-point above the Czech benchmark, said the bank may buy government debt as Europe fights a sovereign-debt crisis threatening to break up the euro area. The Czech central bank has “the luxury” of being able to cut interest rates further before employing unconventional tools, Tomsik said, adding that he would favor measures that decrease longer-term interest rates.
Future Moves
Investors have stepped up bets the Czech central bank will cut borrowing costs after it reduced its outlook for gross domestic product and preliminary GDP data showed the recession continued in the second quarter.
Forward-rate agreements fixing the three-month interbank rate in February dropped to a record low 0.60 percent today, from 0.82 percent before the last monetary meeting. The three- month Prague Interbank Offered Rate, or PRIBOR, was 1.01 percent today. The koruna weakened 0.1 percent before reversing the loss to trade 0.1 percent stronger at 24.879 to the euro as of 12:51 p.m. in Prague.
The central bank’s latest forecast assumed a decline in market interest rates in the “next few quarters,” predicting PRIBOR at 0.3 percent in 2013, followed by an increase in 2014.
“We presented our direction, the forecast signals where market interest rates should move,” he said. “If I see that this isn’t materializing, and if there is a risk of zero or even negative interest rates, I am not ruling out using any instruments, and their combination, to achieve the desired result.”
No Distortions
The Czech financial market isn’t suffering from any distortions or systemic problems such as a lack of liquidity or deleveraging, according to Tomsik, 38. The central bank, whose mandate is price stability, is draining excess funds from the money market as savings at domestic banks exceed loans.
“So any other tools, some may call them unconventional, would reflect the state of the financial market here,” he said.
“In this case, it would make sense to use these additional instruments that wouldn’t be about quantitative effects but about decreasing the long end of the yield curve to achieve stable long-term inflation expectations.”
Tomsik declined to give details of what non-standard policy tools the bank may deploy. Central banks including the ECB, the Federal Reserve and the Bank of England have injected liquidity into financial markets or bought bonds to ease the impact of the euro-area crisis. The Czech central bank may counter economic weakness with zero or negative interest rates and may act to weaken the koruna, Bank of America Merrill Lynch wrote in an Aug. 6 report.
Crisis Impact
Rate setters in Prague are assessing the impact of tax increases the Cabinet plans to introduce next year and the effects of the euro-area debt crisis on the economy. Parliament last month backed new measures, including a higher sales levy, to narrow the fiscal gap to within the European Union’s limit of 3 percent of GDP next year.
Czech inflation is fueled by tax changes, following an increase in the value-added tax at the start of 2012, the impact of past koruna depreciation and commodity costs, while consumer demand isn’t pushing prices up, Tomsik said.
The headline inflation rate has exceeded 3 percent every month this year, dropping to a seven-month low of 3.1 percent in July. Inflation relevant for monetary policy, defined as price growth adjusted for the primary impact of changes in indirect taxes, was 1.8 percent in July, falling below the 2 percent target, according to the central bank. It forecast policy inflation to decline below its goal at the end of 2012.
GDP fell 0.2 percent in the second quarter from the previous three months, the third consecutive contraction, preliminary data published Aug. 14 showed. Retail sales dropped 1 percent from a year ago in June, the fourth straight decline.
“We’ve been registering very weak household consumption in several recent quarters, and its growth rate seems to be the weakest in the modern history of independent Czech Republic,” said Tomsik. “This is also documented in savings levels, which are quite high and are now at pre-crisis levels, meaning people are deferring consumption.”
Czech Central Bank Has More Room to Cut Rates, Policy Maker Says
The Czech central bank has more room to cut interest rates before it applies less conventional policy tools to ease monetary conditions, Vice Governor Vladimir Tomsik said.
Tomsik commented on economic trends and the monetary-policy outlook in an interview in Prague yesterday.
NEW FORECAST AND ECONOMIC TRENDS:
“The new forecast includes a significant slowdown in economic growth in the effective euro zone, representing the Czech Republic’s main trading partners, and that is one of the most important factors for me.
‘‘The forecast reflects expectations of a great decline in market-interest rates in the euro zone, which would bring them to an even lower level than after the collapse of Lehman Brothers.
‘‘This means our new forecast clearly assumes a significant decline in foreign demand, and it also assumes a notable weakening of domestic demand.
‘‘The only inflation pressures are now coming from the tax changes, the impact of past depreciation of the exchange rate and commodity prices. I don’t see demand-driven inflation.
‘‘The flash GDP estimate is the first more important piece of information that certainly isn’t speaking against the latest forecast.
‘‘We have been registering very weak household consumption in several recent quarters, and its growth rate seems to be the weakest in the modern history of the independent Czech Republic.
This is also documented in savings levels, which are quite high and are now at pre-crisis levels, meaning people are deferring consumption.’’
ON MONETARY POLICY OUTLOOK:
‘‘It’s possible to take a wait-and-see approach, as the majority of the board members did. I didn’t choose that approach, because if you take the wait-and-see approach, and the forecast materializes, then it means that a stronger policy action will be needed.
‘‘I will be asking how great is the risk that the absence of an action now, to lower interest rates, could result in inflation moving below the forecast.
‘‘The forecast already assumes lower interest rates in the next several quarters. It’s still possible to make up for this delay, but the wait-and-see approach means running the risk of applying sharper steps.
‘‘The good news for me is that the market interest rates, and outlook expressed in FRA rates, are showing a declining tendency. So the trend is in line with the forecast; the question is how to reach the absolute levels.’’
ON POLICY INSTRUMENTS:
‘‘One of the tools of monetary policy is transparent communication. I personally think that sometimes it’s not necessary to conduct monetary policy through adjusting interest rates by decimal points, but it may be enough to signal our intention and the market will follow.
‘‘In this respect, we presented our direction now, the forecast signals where market interest rates should move. If I see that this isn’t materializing, and if there is a risk of zero or even negative interest rates, I am not ruling out using any instruments, and their combination, to achieve the desired result.
‘‘For me, a zero interest rate is a technical barrier, which we don’t necessarily have to reach. It may be enough if market interest rates fulfill the assumptions of the forecast.
And if it doesn’t happen, I am personally ready to take all necessary steps to achieve our inflation target and help stabilize inflation expectations.
‘‘The Czech financial market is healthy and fully functioning, and, compared with some markets abroad, we don’t need to correct any distortions here.
‘‘There is no crisis of confidence in the Czech financial market, there is no problem with liquidity, there is no need to correct any systemic problems of banks or deleveraging.
‘‘So any other tools, some may call them unconventional, would reflect the state of the financial market here. In this case, it would make sense to use these additional instruments that wouldn’t be about quantitative effects but about decreasing the long end of the yield curve to achieve stable long-term inflation expectations. If I were to act, I would be aiming to prevent a shift into deflation expectations.
‘‘I don’t want to mention any specific instruments now, because we still have the luxury of not fully exhausting the room for adjusting interest rates. I’m sure that at the moment when there is a risk to inflation expectations, and the scope for adjusting interest rates was used up already, we will be ready to apply other tools.
‘‘It will be up to the bank board to choose the instruments that will be the most effective in achieving the desired result, but also instruments that will represent the least possible risk for achieving the inflation target, risk for the credibility of the CNB as well as the risk for the whole economy.
‘‘For me, it wouldn’t be about monetary-policy transmission or quantitative effects. It would be about influencing the long- end of the yield curve, because until now we have been focusing mostly on the short end.
‘‘If there is a risk of inflation being below the target, or even a risk of deflation expectations, I can personally imagine making a commitment to do everything that is needed to return inflation expectations toward the inflation target.’’