Answers to questions from Reuters (30.8.2010)
1) Three of your colleagues have expressed support for tighter monetary policy in the next few months, thereby questioning the latest quarterly forecast, which assumes stability of market rates followed by a gradual rise in rates in the second half of next year. At the same time, the risks of the forecast were slightly anti-inflationary.
What is your view on the evolution of the economy compared to the forecast?
Do you agree with the path of market rates and therefore also of monetary policy rates assumed by the forecast? Or have there been any changes? If so, what are they?
Consistent with our forecast (still valid until November) is stability of market interest rates initially, followed by a gradual rise in rates as from the second half of 2011. The forecast is a guide both for us and for the market as to how we view the evolution of the economy. It allows us to maintain transparency when deciding on interest rates if the risks of the forecast are clearly defined and explained.
At the last Bank Board meeting at the beginning of August, the risks of the forecast were described as being slightly anti-inflationary, as we identified two tangible anti-inflationary risks at that time: the then rapid appreciation of the exchange rate and the planned fiscal consolidation. On the other hand, we identified only a relatively vague risk of commodity price growth. In my opinion, only the anti-inflationary risk has clearly materialised since then, as work on the fiscal reform is continuing at quite a brisk pace. This implies that I personally agree with the interest rate path implied by the current forecast.
2) What effect is the exchange rate – which in recent weeks has been above the levels assumed in the forecast (and conversely, the average exchange rate since the start of the year is just below the average assumed rate) – having on the evolution of inflation risks and interest rates?
Although the sharp appreciation observed in the weeks before the monetary policy meeting has now halted, we are still roughly 30 hellers below the forecast assumption for 2010 Q3. However, the forecast assumes levels of around CZK 24.90 to the euro in 2010 Q4, so I don’t see any tangible reason here that would invalidate the current forecast.
3) Data from Germany are indicating a stronger recovery of the German economy, but there is negative news coming from the United States. In which direction are the risks of the forecast moving as regards the real economy?
The recent developments in Germany are good news for us, as our links with Germany are much closer than those with the United States. Accordingly, the flash estimate of Czech GDP in 2010 Q2 is slightly above our forecast. However, that does not necessarily mean an upward risk to inflation. A faster recovery in our main trading partner countries (especially Germany) may “paradoxically” have anti-inflationary effects via a strengthening koruna (growth in foreign exchange income due to rising Czech exports). So, for our forecast, a stronger and faster recovery in Germany represents not only a risk of further postponement of rate increases; even a return to the debate about cutting rates cannot be ruled out.
4) What impact are commodity prices having on the price forecasts... crop prices are going up, oil is close to the forecast...
Compared to the estimates on which the previous forecast is based, the August outlook for Brent crude oil prices is 9% higher on average. The Brent crude oil price is thus expected to rise from the current USD 75 a barrel to USD 82 at the end of 2012. The revision of the outlook for petrol prices is similar to that for oil prices. However, the higher outlook for oil and petrol prices is offset by the outlook for a stronger euro against the dollar. The euro is 4% stronger against the dollar at the forecast horizon compared to the previous assumptions, with the outlook fluctuating in the range of USD 1.2–1.3 to the euro. If we factor in the previously mentioned risk of a stronger koruna against the euro, I believe that the impact of world prices of energy-producing materials on domestic prices will not be significant.
As regards food prices, the current forecast assumes an upswing in food price inflation to about 3.5% year on year at the end of 2010 and the start of 2011. Growth in food prices has thus been revised upwards compared to the previous forecast.
5) Some of your colleagues are saying that it is bad to have rates below the ECB level and that it is inappropriate to have zero or negative real interest rates. How do you view this opinion?
If Czech nominal interest rates are just a few basis points lower than European ones, I don't think there is any danger of a major outflow of capital. Besides the interest rate differential, investors take into account both exchange rate variability and the long-term appreciation trend. Although Czech monetary policy rates are now below the ECB rate, interbank money market rates are still above euro rates in nominal terms. But even if longer-term rates dropped below the euro area level, nothing dramatic would happen. For example, our economy had lower three-month nominal rates than the euro area for more than 40 months in 2005–2008. This is certainly one of the reasons why we have the lowest proportion of foreign currency loans in the region and why our banking sector is not in a net debtor position towards non-residents. These factors were both significant contributors to the stability of Czech banks during the crisis.
As regards zero or negative real interest rates, I must agree that they are not desirable for the economy in the long term, as they clearly contribute to the emergence of asset market bubbles and to the misallocation of capital. Nevertheless, this unsound mechanism operates mainly when real interest rates on new loans are very low, which is what really allows bubbles to inflate. Although monetary policy interest rates are at a historical low, rates on new loans to corporations and households are not. Real ex ante interest rates on loans are mostly above 2% for corporations and above 3% for mortgages, so they are some distance away from being zero or negative. Excessively rapid growth in the volume of loans is virtually always a symptom of unhealthily low real interest rates. However, loans are broadly flat in the Czech Republic and are even declining in some segments, so I do not regard the current level of real interest rates as being too low. Based on the credit and property market data and the household savings data, there are no signs that the current interest rate level is giving rise to any unsound tendencies going forward (demand overheating, excessive credit expansion, price bubbles, etc.). The CNB is monitoring all these indicators very closely in order to hit the inflation target and to ensure financial stability while maintaining its current well-functioning monetary policy framework and transparent communication with the market.
Vladimír Tomšík, CNB Vice-Governor