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Minutes of the Board Meeting on 20 December 2001

8.1.2002 10:05

The December situational report indicated that, in comparison with the October 2001 forecasts, the significant factors causing a decline in inflation and economic growth were still present. Based on this information, the inflation and GDP growth forecast for 2002 could be expected to shift downwards in the large situational report in January 2002, which would bring about a comprehensive reassessment of the forecasts. Nevertheless, it was also emphasised that the new information released during December did not give clear signals. Inflation figures for November 2001 were slightly lower than the forecast. On the other hand, data for the real economy did not signal any substantial restraint in growth dynamics.

Year-on-year growth in consumer prices and net inflation in November 2001 was 0.2 percentage points lower than predicted. This development was primarily generated by the rapid year-on-year drop in import prices, caused in particular by a decline in world oil prices and other raw materials as well as the appreciation of the Czech koruna. Growth of industrial and agricultural producer prices also significantly slowed. As a result, external cost factors had a favourable effect on inflation, and for 2002, this effect would be expected to continue, especially if there were no corrections in the recent appreciation of the koruna. However, after making adjustments for these influences, ”adjusted” inflation, excluding fuel prices, registered a slight acceleration trend since 1999 and was consistent with the recovery phase of the economy.

GDP in the third quarter of 2001 corresponded to the forecast. Growth was stimulated by household consumption and investments, and on the contrary, restrained by negative net export. Thus, the slowdown in foreign demand so far had not affected domestic demand to a greater extent, and consumer as well as investor optimism remained firm during this period. High growth in retail sales for October 2001 also pointed to continued consumer confidence. However, industrial production and the situation on the labour market suggested a certain slowdown in growth. The labour market had seen a halt in employment growth, and the unemployment rate stagnated compared to the same month last year. In the outlook for 2002, the GDP growth forecasts in Germany were now situated between the two scenarios discussed in the October situational report.

Money supply growth was stable and did not signal any significant changes in domestic demand. The yield curves shifted downward and indicated the anticipation of a further decline in short-term interest rates. The interest rate differentials for longer maturities had been reduced and did not offer any motivation for capital flow. This situation, therefore, did not contribute to exchange rate strengthening.

It was said at the beginning of the Board’s discussion that the recent fluctuation in the exchange rate and the CNB’s joint efforts with the Government to solve this situation dominated current monetary development. With the Minister of Finance’s participation in the meeting, detailed information was presented on progress in the negotiations between the central bank and the Government to find a coordinated solution to the effects of the Czech Republic’s foreign currency incomes on the exchange rate. The intention of both sides to reach a final agreement was again emphasised, and consensus on the principles of the proposed solutions was confirmed.

During the discussion on interest rate settings, some of the board members expressed that the situational report only reflected the risks identified in previous months. At the end of November 2001, the CNB had responded to these risks with a rate cut. The newly available information would not lead to increased pessimism concerning external demand next year. It was said that disinflation tendencies were caused to a great extent by exogenous cost factors, while internal economic development did not signal any significant weakening in domestic demand. It was also stressed that monetary policy should be more forward-looking and account for the fact that some conditions in the economy were still set in a relatively unrestrained fashion. For example, fiscal policy continued to be expansive. After the external slump died out and credit issue recovered, this could put pressure on higher interest rate levels. However, at this time, real monetary policy rates were very low, and real interest rates on deposits had been negative for some time. One view expressed that wage development was still a risk factor. Lower growth for GDP and prices would mean higher nominal and real unit-labour costs given the current nominal wage growth forecasts. Finally, it was also argued that any potential change in interest rate settings should come out of the updated forecast in January 2002.

On the contrary, some board members stressed that the inflation risks were still significantly downward in nature. In addition to favourable external factors, one view suggested that the wage risk had also substantially weakened, which was indicated by data from the labour market and by some signals from collective bargaining. There was a concern that inflation next year would head towards the lower boundary of the targeted band or even slip temporarily below it. Signals from the real economy were seen to be mixed. There was rapid growth in retail sales, while sales in industry were less optimistic. In this particular situation, the present strengthening of the exchange rate resulted in an inappropriate tightening of monetary conditions, and the CNB should try to compensate for this development.

The Board also discussed the use of foreign exchange intervention, because recent developments had shown an unprecedented fluctuation in the exchange rate. Despite consensus on the crucial importance of the agreement with the Government, it was also stressed that the CNB still had its standard instruments at its disposal, including intervention, which it should be prepared to use as supplementary measures if needed. Specific factors relating to the end of the year were discussed. Attention was given, among other things, to the financial and real effects of a strong year-end exchange rate on company performance and to low market liquidity that could increase the volatility of the exchange rate and disconnect it from fundamentals. In this respect, it was expressed that a certain form of market liquidity support was consistent with the CNB’s efforts to reduce market volatility.

At the close of the meeting, the Board decided to leave the CNB two-week repo rate unchanged at 4.75%. Four board members were in favour of this decision, and three members voted for lowering the monetary policy interest rates by 0.25 percentage points.

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 (Minister of Finance)

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