Minutes of the Bank Board Meeting on 25 April 2002
The Board discussed the 4th situational report on economic and monetary development, which contained the new forecast for 2002 and 2003. The report confirmed the continuation of trends in the Czech economy and the external environment that had first emerged at the end of last year. Domestic demand strengthened economic growth, while foreign demand (net export) continued to decline. The rise in oil prices signalled a weakening of the exogenous disinflationary cost shock. The indicators and estimates of economic development abroad pointed to slow recovery. Consumer prices were consistent with the inflation targets. In addition, prices in the tradable commodities sector had been flat over the longer term.
The sharp appreciation of the Czech koruna presented a growing threat to macroeconomic stability. With no change in key policy rates, this meant a substantial tightening of monetary conditions. How and when the exchange rate would return to a trajectory corresponding more to fundamentals was a significant uncertainty for the inflation forecast.
According to the new inflation forecast, year-on-year consumer price growth was expected to be in a range of 2.1% to 3.1% at the end of this year, in contrast to the previous 2.5% to 3.8%. In 2003 Q2 and Q3, i.e. during the period of the most effective monetary policy transmission, inflation should be situated in the lower half of the targeted band. The GDP growth estimate for this year and next year slightly declined in comparison to the previous forecast. There had been no changes so far in the forecast for the general government deficit (ca CZK 140 billion according to ”Maastricht methodology”) and the trade balance (CZK 90 billion).
In the discussion to follow, the board members stressed that annual inflation would be situated below the targeted band for the rest of 2002 according to the new forecast, and that it should stay in the lower half of the band throughout next year. In view of the decline in inflation and inflation expectations, such development would lead to an increase in real interest rates and, in turn, to further tightening of monetary conditions. The discussion also focused on the risks of the existing forecast. Some views expressed that the potential impact of the exchange rate on investment and domestic demand could imply a further decline in inflation. A similar forecast risk could arise from any increase in the downward flexibility of tradable goods prices.
The Board’s discussion then turned to exchange rate developments. The koruna exchange rate was a problem now, because it had appreciated rapidly over a short period of time. This created a sudden tightening of monetary conditions and put pressure on firms to either very quickly increase productivity or to lower costs. In this context, it was reminded that the ability of firms to quickly adapt was not only hindered by the downward rigidity of material input prices (import), but also by the steady rise in other costs, especially wage costs which had become excessive in the current environment. This had an impact on export companies as well as sub-suppliers and producers for the domestic market who were dealing with the effects of a sudden decline in their competitiveness. The negative consequences of rapid appreciation were expected to surface with a certain time lag.
Board members confirmed their previous theory that the exchange rate during the past weeks was a deviation from the trend that did not respect the basic development of macroeconomic fundamentals. The Board discussed the duration and risk level of this ”bubble” phenomenon. Some of the members recommended waiting for new, more conclusive data on the exchange rate and its effect on economic growth before making any monetary policy move. Among other things, they pointed to the positive perception of economy development, domestic demand and the balance of payments. However other members rejected this argument suggesting that the situation was in need of a flexible response.
At the close of the meeting, the Board decided by a majority vote to cut interest rates by 0.5 percentage points, effective 26 April 2002. As a result, the two-week repo rate was lowered to 3.75%, the discount rate to 2.75% and the Lombard rate to 4.75%. Four members voted in favour of this proposal, one member was in favour of lowering interest rates by 0.25 percentage points and two members voted to leave rates at their current level.
Present at the meeting: Zdeněk Tůma (Governor), Oldřich Dědek (Vice-Governor), Luděk Niedermayer (Vice-Governor), Michaela Erbenová (Chief Executive Director), Jan Frait (Chief Executive Director), Pavel Racocha (Chief Executive Director), Pavel Štěpánek (Chief Executive Director).
Jiří Rusnok (Czech Minister of Finance)